Fixed Interest Rate

A fixed interest rate is a constant rate of interest levied on debts like loans, mortgages, or bonds. It doesn’t fluctuate throughout the fixed rate tenure of the debt. It aids the debtor in accurately predicting future debt repayments and avert interest rate risks. Thus, it is a secure financing option.

A liability may hold a fixed rate for the entire period or throughout a limited duration. It is relatively higher (1%-2%) than a floating interest rate and provides a steady repayment amount. As per the creditor’s terms, the fixed rate on a long-tenure mortgage converts to a floating rate over time.

• Fixed interest rate is a predetermined rate charged on the liability with unalterable monthly installment plans and debt refund period. 
• It shields investors from any market interest rate fluctuations and is mostly employed during periods of low-interest rates. 
• It contrasts with a floating (variable) interest rate in terms of loan duration, EMI, the impact of market conditions, and risk potential. 
• The fixed interest rate benefits borrowers looking for a safe financing option with pre-fixed EMI over the debt tenure. 

An interest rate is the cost of borrowing funds. It is a percentage of the total debt a borrower must pay periodically to the lender. Such a rate may be fixed or variable. A fixed rate denotes an unvarying charge (in annual percent) imposed by the lender on the cash lent.

Unlike the variable rate, which fluctuates with a rate index, the fixed rate remains stable. This gives the borrower the advantage of knowing the exact periodical payments to be made during the loan tenure. This knowledge reduces uncertainty and increases the possibility of a timely mortgage settlement.

Interest rates charged by a lender depend on various economic factors like monetary policies, inflation, etc. Also, borrowers are charged rates based on their individual income and credit scores. Besides, each lender accounts for its operating costs and risk tolerance before settling on the applicable rates.

Suppose Carina has to reimburse a $90,000 home loan to be refunded within ten years at a fixed rate of 6%. Now, she must know three elements to calculate the interest repayment, i.e., loan amount, interest rate, and loan repayment term. 

Here, 

• Loan amount = $90,000
• Fixed interest rate for home loan (annual) = 6%
• Loan period = 10 years

Hence, 

• Annual interest payment = $90,000 x 6% = $5400
• Interest payment for 10 years = $5400 x 10 = $54,000

So, Carina’s total interest to be paid within 10 years is $54,000. 

The total amount to be repaid = Loan amount + Interest

=$90,000 + $54000 = $144,000

The benefits and drawbacks of opting for a fixed rate against a variable rate may depend on the financial market conditions.

Pros

1. Security – A fixed rate safeguards the debtors from an unexpected growth in equated monthly installment (EMI) resulting from an increase in the market rate of interest. Thus, a fixed rate offers immunity from interest rate risks and protects the borrower over the term of the debt.
2. Predictability – The borrower is fully aware of how much to shell out each month and how long the advance payments are required. This removes any ambiguity or uncertainty over payments. Therefore, fixed rates ensure safety and certainty.
3. Easy calculation – Since there are no variable elements in calculating EMI, measuring and tracking the payments are relatively uncomplicated. Hence, fixed rates ensure appropriate capital management with a trouble-free remittance. 
4. Planning and budgeting – With the predictability of cash outflows, borrowers can plan their short-term as well as long-term finances with ease. Fixed rates suit meticulous budget planners with an aversion to any major EMI changes. 

Cons   

1. Potential loss due to lower interest rates – Market rates of interest may at times see dips that benefit floating rate loanees substantially. However, fixed-rate borrowers have to continue paying their pre-fixed EMI without any change. 
2. Higher re-compensation amount – Since the loanee does not benefit from the reduction in prices in the case of fixed rates, the loan amount repaid usually turns out to be more than variable rates. Thus, a fixed rate implicates unaltered yearly debt compensation. 
3. Penalty - Debtors may be penalized for partial or complete prepayment of fixed interest debts, subject to the money lending organization. Common for short-term commercial loans, the prepayment penalty charge remains inconsistent.

A fixed rate is ideal for borrowers looking for a specified debt obligation without any risk of fluctuating payments on account of varying market rates of interest. However, before making a choice regarding interest rates, borrowers must consider the unpredictable financial climate or trend.

Borrowers witnessing stable or potentially rising market rates must choose a fixed rate. On the other hand, if they suspect a downward trend in the future, it is ideal to opt for variable interest rates.

Alternately, loanees may switch from fixed to floating rates and vice-versa on applicable charges. However, they must appraise their financial status and requirements before making the final decision. Reset is a key phrase in this context. It infers the shift from the fixed rate on loans to a floating rate with time, subject to moneylenders' terms. 

Recently, the US has disclosed a significant rise in the average contract interest rate for the 30-year fixed interest rate home loan. It rose from 3.83% to 4.05% for loan balances of a maximum of $647,200. As the rates increase, there is a fall in the mortgage demand.  However, the average loan size has set a record at $453,000.

Furthermore, the growth in the mortgage rate is attributable to the latest increase in treasury earnings. The treasury rates have soared because of constant inflationary pressures and enhanced market expectancy from the Federal Reserve to step up its efforts to reduce inflation.

This has been a guide to Fixed Interest Rate & Definition. Check out the calculation of fixed interest rate on home loan & its comparison with floating rate. You may also have a look at the following articles to learn more –

• Interest Rate Effect
• Interest Rate Parity
• Negative Interest Rate