Skip to content
View all posts

What is a Home Loan? A Complete Guide for Beginners

What is a Home Loan? A Complete Guide for Beginners

Buying a home can be the largest purchase you’ll ever make. For most people, this isn’t possible without financial assistance. That’s where a home loan—also known as a mortgage—comes in. If you’re planning to buy your first home or want to understand how home loans work, we can help! Here’s all you need to know about home loans. 

 

What is a home loan?

 

A home loan is a type of loan provided by a bank, credit union or mortgage lender to help you purchase a property. Instead of paying the full price upfront, you borrow money to cover the cost and repay it over time in monthly installments. These payments include two main components:

 

  1. Principal: The original amount you borrow.

  2. Interest: The cost of borrowing, expressed as a percentage of the loan amount.

 

Home loans are secured loans, meaning the property itself serves as collateral. If you fail to make your payments, the lender can take possession of the home through a process called foreclosure.

 

How does a home loan work?

 

When you take out a home loan, you agree to repay the borrowed amount over a set period of time, usually 15, 20 or 30 years. Each monthly payment is applied toward the principal and interest. Over time, as you pay off more of the principal, the interest portion of your payment decreases.

 

Key components of a home loan

 

  • Down payment. This is the initial amount you pay upfront when purchasing a home. It’s typically expressed as a percentage of the home’s purchase price (e.g., 10% or 20%).

A larger down payment can lower your loan amount, reduce your monthly payments, and potentially secure a better interest rate.

  • Interest rate. The interest rate is the cost of borrowing money and can be fixed or variable. In a fixed-rate mortgage, the interest rate remains the same throughout the loan term, offering consistent monthly payments. In an adjustable-rate mortgage (ARM) though, the interest rate starts low and adjusts periodically based on market conditions, potentially leading to fluctuating payments.

  • Loan term. The loan term is the time period over which you agree to repay the loan. Common terms are 15 or 30 years. In a 15-year loan, you’ll have higher monthly payments but lower total interest costs, while in a 30-year loan, you’ll enjoy lower monthly payments but have higher total interest costs due to the extended repayment period.

  • Closing costs. These are fees paid during the home-buying process, including appraisal fees, loan origination fees, and title insurance. Closing costs typically range from 2% to 5% of the loan amount.

 

Types of home loans

 

  1. Conventional loan-not backed by the government and often require a higher credit score and a larger down payment.

  2. FHA loans-insured by the Federal Housing Administration (FHA) and designed for first-time buyers or those with lower credit scores. They often require a smaller down payment.

  3. VA loans-available to eligible veterans and active-duty military members, these loans are backed by the Department of Veterans Affairs and usually don’t require a down payment.

  4. USDA loans-for low- to moderate-income buyers in rural areas, backed by the U.S. Department of Agriculture, often with no down payment required.

 

How to qualify for a home loan

 

To qualify for a home loan, lenders evaluate several factors:

 

  1. Credit score. A higher credit score can help you secure a lower interest rate.

  2. Debt-to-income (DTI) ratio. This measures how much of your income goes toward debt payments. Lenders prefer a DTI below 43%, but some will approve a loan for a borrower with a DTI of 30%.

  3. Income and employment history. Stable and sufficient income assures lenders of your ability to repay the loan.

  4. Down payment. The amount you can afford to put down influences your loan eligibility and terms.

 

A home loan is a powerful tool that makes homeownership accessible to millions of people. By understanding how home loans work, the types available, and the factors that influence your loan terms, you can approach the home-buying process with confidence. 

 

If you’re ready to take out a home loan today, look no further than Garden Savings! Our home loans offer competitive rates, easy pre-approvals and the ongoing support of our team throughout the home-buying process. Call, click or stop by today to learn more. 

 

Sources:

https://www.investopedia.com/terms/h/home-mortgage.asp

https://www.rocketmortgage.com/learn/what-is-a-mortgage

https://yourhome.fanniemae.com/buy/understanding-home-loan-basics

Garden Savings Federal Credit Union

The local credit union in your neighborhood.

A Better Place to Bank.