Home financing loans: What you should know
The modern home financing loan market offers a variety of home financing loans that cater to the needs of homebuyers. The names and details of these plans can become confusing, especially since new types are introduced all the time. You can make sense of these loan types, however, if you understand the basic principles that govern all home financing loans. Look to your Realtor for assistance.
Basic principles of all home financing loans
- The home is used as security to back up the loan. A lender can force sale of the home if the borrower defaults by failing to make scheduled payments.
- The larger the loan compared to the value of the home, the riskier it is for the lender. As a result, the loan is often more expensive.
- Interest earned by the lender always is equal to the periodic interest rate times the outstanding principle balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in the year (usually one per month).
- The required payment usually is a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process, called amortization, explains why most home financing loans can be retired when all the monthly payments have been made.
- All home financing loans have one of the following features:
- Fixed payment and fixed interest rate – fixed rate mortgages
- Fixed rate but variable payment – graduated payment mortgages
- Variable rate and variable payment – adjustable rate mortgages (ARM)
- As you learn more about the types of home financing available, you will notice that some loans appear to have more favorable terms. That may indicate that those loans are, indeed, bargains (and it does pay to shop around), but usually it means that those loans could have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. However, the monthly payment for the same amount of principal may be higher because of the shorter term. Variable rate loans usually have much lower interest rates to compensate for the risk the borrower accepts that interest rates will rise in the future.