Buying a home is a major life event and one of the biggest investments you’ll make in your lifetime. This means you’ll probably have to take out a mortgage, which is basically a big personal loan, to pay for your purchase. And sure, this and any debt can seem worrisome, but it’s totally manageable if you can predict and budget for your monthly mortgage payments. That’s where fixed-rate mortgages come into play, and we’ve detailed them below to show you that, well, buying a home really isn’t that scary!
What is a fixed-rate mortgage?
A fixed-rate mortgage is a home loan for which your interest rate stays the same over the life of the loan. This means that you’ll know your exact principal and interest monthly payments from the get-go, and the rate won’t go up or down. In fact, if you plug your principal, interest, and other key loan terms into a mortgage calculator, you can see your whole payment schedule. We’re not exaggerating – you’ll see each and every month of your loan term broken down into principal and interest. It’s the kind of transparency we love in banking.
Virtually all fixed-rate loans are amortized - this means that, at first, your monthly principal payments are low, and your monthly interest payments are high. Over time, though, this flips — you’ll start paying more in principal and less in interest. The sum of both, though, will always be the same amount. You’ll notice this monthly cost breakdown in your mortgage calculator’s amortization table of monthly principal and interest payments. We recommend paying attention to this — it has tax benefits we’ll get into later. The transparency that comes with amortization is a major reason why fixed-rate mortgages are the most popular type of home loan.
You’ll typically find them offered as 30-year fixed-rate mortgages, but sometimes, you’ll see loans lasting 10, 15, or 20 years too. In fact, here at UBank, we offer all these fixed-rate loan term options through our secondary market investors. We make it that much more accessible to obtain the exact mortgage and monthly payments you want!
The benefits of fixed-rate mortgages
Knowing your exact monthly payment amounts is only one benefit of fixed-rate mortgages. Another huge plus ties into the fact that, in recent years, interest rates have continuously increased. When you get a fixed-rate mortgage, you lock in mortgage rates that don’t increase as these rates keep climbing, thus saving you money.
Additionally, with a fixed-rate mortgage, your early monthly payments comprise mostly interest. That’s great for lowering your tax burden — all interest you pay on a mortgage of up to $750,000 is fully tax-deductible. And since you’ll pay less in taxes, you’ll have more money for paying off your mortgage and affording that dream home.
Between keeping your payments transparent and steady — and nabbing you some pretty great tax deductions — your fixed-rate loan will make your budgeting easier. With your predictable monthly expenses and more money in the bank thanks to your tax deductions, planning for your future becomes that much easier. Plus, with a fixed-rate mortgage, you’ve already checked off what’s probably one of your biggest goals: buying a home!
How mortgage lenders set fixed interest rates
In June 2021, the national average 30-year mortgage interest rate was 3.19%. Two years later, in June 2023, this rate had risen to 6.84%. That’s a huge rate increase with major ramifications for how much your mortgage costs. Lenders set mortgage rates based on the following factors:
- Other assets’ interest rates. Lenders regularly review the difference between the interest rate on mortgage-backed securities and U.S. Treasury bonds. They often add a margin to this difference to set their home loans’ rates.
- The state of the economy. When the economy grows, so too do interest rates, and the opposite is true as well. A great recent example is that, during the lockdown period of the COVID-19 pandemic, people still bought houses aplenty. That’s because, given the sudden and rapid drop in economic activity, interest rates plummeted. Savvy homebuyers swooped in and obtained fixed-rate mortgages at low rates you simply couldn’t find just a year later.
- The Federal Reserve. When the Fed increases or decreases interest rates, mortgage rates change too. That’s because borrowing money is more expensive when rates are higher, so banks must charge higher mortgage rates to profit from their loans. Of course, when the Fed lowers rates, banks can charge lower rates too, and that’s great for you.
- Inflation. This kind of goes hand in hand with the Fed’s impact. In theory, if the Fed increases rates and borrowing becomes tougher, spending decreases. The resulting drop in consumer demand should lessen inflation, which is why the Fed often raises rates to counter inflation. It follows, then, that when inflation is high, mortgage rates are high too. In fact, this is basically the main reason for the huge increase in mortgage rates from June 2021 to June 2023.
These interest rate factors pertain to the world beyond your control — they have nothing to do with your own financial situation. Plenty of your personal financial factors, though, can shape the interest rates that banks offer you.
Fixed-rate mortgage eligibility and qualifications
If you’ve got great personal finances, any type of mortgage could be on the table for you. Here are the personal financial factors that lenders look at when deciding whether you’re loan-worthy.
- Your credit score. Since your credit score shows how reliably you will or won’t repay loans, it’s among the very first things lenders review. A low score could put loans wholly out of reach for you, whereas a high score could help you secure significantly lower interest rates.
- Your down payment. The size of your down payment plays a part in figuring what your final rate could end up being. In fact, your mortgage rate will often correspond with something called your loan-to-value ratio (LTV). This figure is the difference between 100% and your down payment. For example, a 20% down payment — the amount you must pay to avoid private mortgage insurance — means an 80% (100% – 20%) LTV.
- Your loan amount. Some banks operate on the principle that higher-value loans are less risky. These banks might offer lower interest rates to borrowers taking out larger loans. That said, a larger loan corresponds with a smaller down payment that can increase your rate. You can probably start to see why banks have to put so much time and effort into getting you a quote for your mortgage. It’s the kind of work we love to do at UBank — and we do it all for you.
- Your closing costs. When you buy a home, you also pay for all the services that go into finalizing your contract. Many of these costs are fixed and are the same for every size loan, however, a few are driven by the size of the loan. These costs could reach as high as 2-6% of your loan - and when your loan is for hundreds of thousands of dollars, that's a lot!
- Your debt-to-income ratio (DTI). In general, being financially healthy means that, when you divide your debt by your income, it comes out to at most 35%. That said, it’s totally possible to get a mortgage if your DTI is up to 45%, though it’s definitely harder!
- Your income. Beyond how it shapes your DTI, your income is how lenders decide whether to approve you for a mortgage. Approval is much more likely if you have two years of steady employment within one field. That’s a bigger factor than any sort of annual gross income floor — in fact, you’ll rarely encounter these. You can use pay stubs, W-2 tax forms, and official letters of employment to prove your income.
Fixed-rate mortgages vs. other types of mortgages
Fixed-rate mortgages aren’t the only type of mortgage — there are also adjustable-rate mortgages (ARMs) and interest-only mortgages. You might be drawn to ARMs because interest rates could drop, meaning your mortgage rate could too. ARM loans aren't quite as simple as they seem - or as stable and predictable as fixed-rate mortgages.
Since ARMs change based on an index tied to the loan, you could wind up with a more expensive loan in the long run. Fixing your mortgage rate from the get-go protects you against your costs increasing as interest rates rise.
Additionally, when comparing fixed-rate and interest-only loans, paying both principal and interest from the first day is actually a good thing. Fixed-rate loans eliminate any surprises.
Meet your mortgage matchmaker today
Mortgage loans are much easier to navigate when there’s someone — an actual person, who you know in real-life — advocating on your behalf. Here at UBank, our team is always excited to meet you, answer your mortgage questions, and get you from application to closing. Plus, you can apply for a UBank mortgage right now by using our online application tool. If you’d rather talk with our mortgage team before applying, we’d love for you to visit the nearest UBank location to get started. The home of your dreams is right around the corner!