In a fixed-rate loan (also called a term loan), the interest rate stays the same for the loan’s entire term. For example, you could have a loan with a 15-year amortization and a five-year term. During that five-year term, the interest rate would be “locked in.”
Fixed-rate loans are typically used to pay for fixed assets (those that will be used for 60 months or more). The payments on a fixed-rate loan are blended, meaning they combine interest and principal in an equal monthly amount that does not change over the term of the loan.
The principal amount of the loan and the rate are set by a contract. These contracts are called fixed-rate loan agreements. These bind both the lender and the borrower to the deal. Under a fixed-rate loan agreement, as long as the borrower makes payments as scheduled, the lender cannot demand repayment. Also, the borrower cannot pay off the loan ahead of schedule without the lender’s permission.
If the lender agrees to early payment of the loan, the borrower usually must pay penalty fees, which can be substantial. The penalty fees compensate the lender for revenue lost on the matched funds.
Fixed-rate loans make budgeting predictable, which can be beneficial to a business.