Fixed Rate Loan
A fixed rate loan is a type of loan that carries an interest rate that remains the same for the entire term of the loan. Regardless of market fluctuations or changes in the prime rate (the best interest rate available, often influenced by a country’s central bank), the interest rate on a fixed rate loan does not change.
This type of loan provides a predictable repayment schedule for the borrower. Since the interest rate stays the same, the amount of the monthly payment (which includes both principal and interest) also stays the same. This can be beneficial for budgeting purposes, as the borrower knows exactly what the loan payment will be each month.
Fixed rate loans are common in a variety of lending situations. For example:
- mortgages: Many home loans are fixed rate mortgages, typically with terms of 15, 20, or 30 years. The borrower pays the same amount each month, making it easier to plan housing expenses.
- Auto Loans: Many auto loans also have fixed interest rates. The borrower knows exactly how much they need to pay each month until the vehicle is fully paid for.
- Student Loans: Some student loans have fixed interest rates. However, the rates for federal student loans may change from year to year for new loans, though once the loan is taken out, the rate remains fixed for that loan.
- Personal Loans: Personal loans can also be offered with fixed interest rates, providing predictable monthly payments for the borrower.
The opposite of a fixed rate loan is a variable rate or adjustable rate loan, in which the interest rate can change over time based on changes in an underlying interest rate index.
Example of a Fixed Rate Loan
Let’s consider an example of a fixed rate loan in the context of a home mortgage.
Suppose you’re buying a home that costs $300,000. You make a down payment of $60,000 (20% of the home price), so you need a mortgage loan of $240,000 to cover the rest of the cost.
Let’s say you obtain a 30-year fixed rate mortgage with an interest rate of 3.5%. This means that the interest rate will stay at 3.5% for the entire 30-year term of the loan, regardless of any changes in market interest rates during that time.
Using a standard mortgage calculator, you can determine that the monthly payment for this mortgage will be about $1,077. This payment includes both principal and interest, and it will stay the same for all 360 months (30 years * 12 months/year) of the mortgage term.
Having this fixed monthly payment makes it easier for you to budget your housing expenses. You know that, as long as you make your mortgage payments on time, your housing costs won’t increase due to rising interest rates. Conversely, you also won’t benefit from decreases in market interest rates unless you decide to refinance your mortgage.
In contrast, if you had an adjustable-rate mortgage, your interest rate might change periodically (such as once a year), which would cause your monthly payment to change as well. This could make budgeting more challenging, but it could also potentially allow you to benefit from falling market interest rates.