Fixed-Rate Mortgage – Definition

Cite this article as:"Fixed-Rate Mortgage – Definition," in The Business Professor, updated November 30, 2018, last accessed May 25, 2020, https://thebusinessprofessor.com/lesson/fixed-rate-mortgage-explained/.

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Fixed-Rate Mortgage Definition

A fixed-rate mortgage is a loan where the debtor has to pay a fixed interest for the entire loan term. Usually, lenders provide either fixed, variable or adjustable mortgage loans. The fixed-rate mortgage loan is one of the most common mortgage products.

A Little More on What is a Fixed-Rate Mortgage

Fixed-rate mortgages are loans having a fixed installment structure. As the amortization schedule progresses, the principal amount becomes bigger while interest becomes smaller. Some fix-rate loans are amortized non-amortized. Amortized loans require fixed payments made up of interest and principal. The principal owed reduces throughout the life of the loan. A non-amortized loan requires payments of only interest, (“interest-only loan”). The principal is repaid in a lump sum (a “balloon payment”) at the end of the loan period. In a fluctuating market, fixed-rate loans lower the risk for borrowers and increase risk for the lender.

References for Fixed-Rate Mortgages

Academic Research on Fixed-Rate Mortgage

The impact of the agencies on conventional fixedrate mortgage yields, Hendershott, P. H., & Shilling, J. D. (1989). The Journal of Real Estate Finance and Economics2(2), 101-115. This paper analyses the impact of the movement of Fannie Mae and Freddie Mac mortgage from negligible participants to dominant players in the market. Findings show that between the early 1980 and 1986, shares of conventional fixed-rate mortgages rose from 5% to 50% in these pools. Analysis show that the loan rate depends on the loan-to-value ratio, the loan size, and, in 1986, whether the loan is far above, just above, or below the conforming loan limit.

A generalized valuation model for fixedrate residential mortgages, Kau, J. B., Keenan, D. C., Muller, W. J., & Epperson, J. F. (1992). Journal of money, credit and banking24(3), 279-299. This paper develops a model to rationally price fixed-rate mortgages, using the arbitrage principles of option pricing theory. The paper incorporates amortization, prepayment and default in valuing the mortgage. Finally, by presenting a complete model, the paper yields insights for the existence of common institutional practices.

Choosing between fixed and adjustable rate mortgages: Note, Dhillon, U. S., Shilling, J. D., & Sirmans, C. F. (1987). Journal of Money, Credit and Banking19(2), 260-267. This article reports on the determinants of the ARM choice for commercial real estate projects. The theoretical literature suggests that commercial real estate projects are more likely to be financed with an adjustable-rate mortgage (ARM) if the project’s income stream or value is expected to rise with inflation over time. The empirical model estimated is a structural probit probability model of the ARM choice. Results show that commercial mortgage borrowers will ordinarily be reluctant to issue an ARM when the fixed interest rate is low.

A dynamic analysis of fixed-and adjustable-rate mortgage terminations, Calhoun, C. A., & Deng, Y. (2002). In New Directions in Real Estate Finance and Investment (pp. 9-33). Springer, Boston, MA. This paper provides a side-by-side comparison of loan-level statistical models for fixed- and adjustable-rate mortgages. Multinomial logit models for quarterly conditional probabilities of default and prepayment are estimated.

Securitization and the fixedrate mortgage, Fuster, A., & Vickery, J. (2014). The Review of Financial Studies28(1), 176-211. This paper explores the domination of fixed-rate mortgages (FRMs) in the U.S. mortgage market when it comes to certain factors. It fruther shows that the FRM market share is sharply lower when mortgages are difficult to securitize, exploiting plausibly exogenous variation in access to liquid securitization markets generated by a regulatory cutoff and time variation in private securitization activity.

Fixed rate or index-linked mortgages from the borrower’s point of view: A note, Statman, M. (1982). Journal of Financial and Quantitative Analysis17(3), 451-457.

 

An improved fixedrate mortgage valuation methodology with interacting prepayment and default options, Sharp, N. J., Newton, D. P., & Duck, P. W. (2008). The Journal of Real Estate Finance and Economics36(3), 307-342. This paper considers in detail a realistic mortgage valuation model (including the potential for early prepayment and the risk of default), based on stochastic house-price and interest-rate models.

The valuation at origination of fixedrate mortgages with default and prepayment, Kau, J. B., Keenan, D. C., Muller, W. J., & Epperson, J. F. (1995). The Journal of Real Estate Finance and Economics11(1), 5-36. This paper develops a model to rationally price fixed-rate mortgages, using the arbitrage principles of option pricing theory. The paper incorporates amortization, prepayment and default in valuing the mortgage. Finally, by presenting a complete model, the paper yields insights for the existence of common institutional practices.

Mortgage choice and the pricing of fixedrate and adjustable-rate mortgages, Krainer, J. (2010). FRBSF economic letter3, 1-5. This Economic Letter reviews some of the factors determining consumer mortgage choices. It shows that ARM share has declined in ways that parallel the behavior of several key mortgage market interest rates. To help understand this dynamic, this Letter estimates that the ARM share might have been under alternative scenarios in which fixed mortgage rates were higher, which would likely have been the case if the Fed had not been intervening in the market to the extent that it did.

Option theory and floating-rate securities with a comparison of adjustable-and fixedrate mortgages, Kau, J. B., Keenan, D. C., Muller III, W. J., & Epperson, J. F. (1993). Journal of business, 595-618. This article demonstrates how to value floating-rate securities, in particular adjustable-rate mortgages, in the presence of default.

The relative termination experience of adjustable to fixedrate mortgages, Cunningham, D. F., & Capone Jr, C. A. (1990). The Journal of Finance45(5), 1687-1703. Our study uses a multinomial logit model to analyze the concurrent termination experience of adjustable‐rate and fixed‐rate mortgages. The model also shows that interest‐rate expectations affect FRM terminations more strongly than ARM terminations.

 

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