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Encyclopedia > Fixed rate mortgage

A fixed rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, or for a defined period established at the outset, and is initially based on an index. This is done to ensure a steady payment amount for the borrower. Other forms of mortgage loan include interest only mortgage, graduated payment mortgage, adjustable rate mortgage, negative amortization mortgage, and balloon payment mortgage. Please note that each of the loan types above except for a straight adjustable rate mortgage can have a fixed rate portion to their loan. A Balloon Payment mortgage for example can have a fixed rate for the term of the loan followed by the ending balloon payment. Mortgage loan is the generic term for a loan secured by a mortgage on real property; the mortgage refers to the legal security, but the terms are often used interchangeably to refer to the mortgage loan. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... In economics and finance an index (for example a price index, a stockmarket index) is a benchmark of activity, performance or any evolution in general. ... An interest-only loan is a loan in which for a set term the borrower pays only the interest on the capital; the capital remains owing. ... A graduated payment mortgage loan, often referred to as GPM, is a mortgage with low initial monthly payments which gradually increase over a specified time frame. ... An adjustable rate mortgage or variable rate mortgage is a loan secured on a property (house) whose interest rate and so monthly repayment vary over time. ... In finance, negative amortization, also known as NegAmMort, is an amortization method in which the borrower pays back less than the full amount of interest owed to the lender each month. ... This article needs to be cleaned up to conform to a higher standard of quality. ...


This payment amount is independent of the additional costs on a home sometimes handled in escrow, such as property taxes and property insurance. Consequently, payments made by the borrower may change over time with the changing escrow amount, but the payments handling the principal and interest on the loan will remain the same. Escrow is a legal arrangement in which an asset (often money, but sometimes other property such as art, a deed of title, website, or software source code) is delivered to a third party (called an escrow agent) to be held in trust pending a contingency or the fulfillment of a...


Fixed rate mortgages are characterized by their interest rate, amount of loan, and term of the mortgage. With these three values, the calculation of the monthly payment can then be done.

Contents

Characteristics

Index

All fixed rate mortgages have an interest rate tied to an index. Five common indices in the United States are:

In some countries, banks may publish a prime lending rate which is used as the index. The index is then created as the rate plus some margin. To apply an index on a rate plus margin basis means that the interest rate will equal the underlying index plus a margin. The margin is specified in the note. For example, a mortgage interest rate may be specified in the note as being LIBOR plus 2%, 2% being the margin and LIBOR being the index. A Cost of Funds Index or COFI is a regional average of interest expenses incurred by financial institutions, which in turn is used as a base for calculating variable-rate loans. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ... This article or section does not adequately cite its references or sources. ... Historically, in North American banking, the prime rate was the interest rate charged by lenders to borrowers whom they considered most creditworthy, although this is no longer the case. ...


Terminology

  • Fully Indexed Rate - The price of the FRM as calculated by adding Index + Margin = Fully Indexed Rate. This is the interest rate your loan would be for the life of the loan.
  • Margin - For FRMs where the index is applied to the interest rate of the note on an "index plus margin" basis, the margin is the difference between the note rate and the index on which the note rate is based expressed in percentage terms. This is not to be confused with profit margin. The lower the margin the better the interest rate of the loan is. Margins will vary between 2%-7%.
  • Index - A published financial index such as LIBOR used to periodically adjust the interest rate of the ARM.
  • Term - The length of time of the loan. The number of payments is independent of this term, so a 30-year term would have 30 payments for a yearly payment plan, but 360 payments for a common monthly plan.
  • Home Equity Lines of Credit HELOC - Since HELOCs are intended by banks to primarily sit in second lien position, they normally are only capped by the maximum interest rate allowed by law in the state wherein they are issued. For example, Florida currently has an 18% cap on interest rate charges. These loans are risky in the sense that to lenders, they are practically a credit card issued to the borrower, with minimal security in the event of default. They are risky to the borrower in the sense that they are mostly indexed to the Wall Street Journal Prime Rate, which is considered a Spot Index, or a financial indicator that is subject to immediate change (as are the loans based upon the Prime Rate). The risk to borrower being that a financial situation causing the Federal Reserve to raise rates dramatically (see 1980, 2006) would effect an immediate rise in obligation to the borrower, up to the capped rate.

Profit margin is a measure of profitability. ... LIBOR stands for the London Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale (or interbank) money market. ... HELOC is an abbreviation of Home Equity Line of Credit. ... The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... 1980 (MCMLXXX) was a leap year starting on Tuesday. ... For the Manfred Mann album, see 2006 (album). ...

Popularity

Fixed rate mortgages are the most classic form of loan for home and product purchasing in the United States. The most common terms are 15-year and 30-year mortgages, but shorter terms are available, and 40-year and 50-year mortgages are now available (common in areas with high priced housing, where even a 30-year term leaves the mortgage amount out of reach of the average family).


Outside the United States, fixed-rate mortgages are less popular, and in some countries, true fixed-rate mortgages are not available except for shorter-term loans. For example, in Canada the longest term for which a mortgage rate can be fixed is typically no more than ten years, while mortgage maturities are commonly 25 years.


Pricing

Fixed rate mortgages are usually more expensive than adjustable rate mortgages. Due to the inherent interest rate risk, long-term fixed rate loans will tend to be at a higher interest rate than short-term loans. The difference in interest rates between short and long-term loans is known as the yield curve, which generally slopes upward (longer terms are more expensive). The opposite circumstance is known as an inverted yield curve and is relatively infrequent. Interest rate risk is the risk that the relative value of a security, especially a bond, will worsen due to an interest rate increase. ... The US dollar yield curve as of 9 February 2005. ... The US dollar yield curve as of 9 February 2005. ...


The fact that a fixed rate mortgage has a higher starting interest rate does not indicate that this is a worse form of borrowing compared to the adjustable rate mortgages. If interest rates rise, the ARM cost will be higher while the FRM will remain the same. In effect, the lender has agreed to take the interest rate risk on a fixed rate loan. Some studies [1] have shown that the majority of borrowers with adjustable rate mortgages save money in the long term, but that some borrowers pay more. The price of potentially saving money, in other words, is balanced by the risk of potentially higher costs. In each case, a choice would need to be made based upon the loan term, the current interest rate, and the likelihood that the rate will increase or decrease during the life of the loan. Interest rate risk is the risk that the relative value of a security, especially a bond, will worsen due to an interest rate increase. ...


Prepayment

Fixed rate mortgages, like other types of mortgage, may offer the ability to prepay principal (or capital) early without penalty. Early payments of part of the principal will reduce the total cost of the loan (total interest paid), and will shorten the amount of time needed to pay off the loan. Early payoff of the entire loan amount through refinancing is sometimes done when interest rates drop significantly.


Criticism

Fixed Rate Mortgages can sometimes give a false sense on stability in home costs, when other factors such as property taxes, property insurance, and property repairs are outside the scope of the mortgage, compared to renting where those costs are absorbed by the property owner. However, these factors are also an issue in variable-rate mortgages.


See also

A VA loan is a mortgage loan in the United States guaranteed by the Veterans Administration. ... This article or section may be excessively or inappropriately using first or second person, contrary to the formal tone expected of an encyclopedia entry. ...

External links


  Results from FactBites:
 
Fixed rate mortgage - definition of Fixed rate mortgage in Encyclopedia (1689 words)
The mortgage is an instrument that the borrower (called the mortgagor) uses to pledge real property to the lender (called the mortgagee) as security for a debt, also called hypothecation.
Since mortgage debt is often the largest debt owed by the debtor, banks and other mortgage lenders run title searches of the real property to make certain that the lien of the mortgage is prior to anyone else's claim.
When the landowner fails to perform on the obligation secured by the mortgage, the mortgage holder must file a foreclosure to cause the property to be sold at auction, usually by the sheriff.
Mortgage - Wikipedia, the free encyclopedia (3221 words)
Since mortgage debt is often the largest debt owed by the debtor, banks and other mortgage lenders run title searches of the real property to make certain that there are no mortgages already registered on the debtor's property which might have higher priority.
At common law, a mortgage was a conveyance of land that on its face was absolute and conveyed a fee simple estate, but which was in fact conditional, and would be of no effect if certain conditions were not met --- usually, but not necessarily, the repayment of a debt to the original landowner.
Hence the word "mortgage," Law French for "dead pledge;" that is, it was absolute in form, and unlike a "live gage", was not conditionally dependent on its repayment solely from raising and selling crops or livestock, or of simply giving the fruits of crops and livestock coming from the land that was mortgaged.
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