If you're about to apply for your first home loan, you should know the basics of home loans.
How a home loan works
When you go to get a home loan, you need to know how to talk about it. Let's start with the simplest words.
- Interest: Every mortgage loan has a rate of interest. The interest rate is how much you have to pay to borrow the principal from a lender. Interest rates are usually the most important part of a loan, since there are so many different kinds of loans with interest rates that can change every year, every few years, or just stay the same over time. Most of the time, you want the interest rate to be as low as possible.
- Principal: The principal is the amount of money you borrow to buy the house you want. If you ask for a $250,000 loan, the amount the bank gives you is called the "principal amount."
- The loan's term is the number of months you have to pay back the money you borrowed from the lender. For example, a 30-year fixed-rate mortgage means that 360 monthly payments will be made over the course of 30 years. Don't worry, there are loans that can be paid back in much less time.
Amortization
Amortization is not only hard to say, but it's also a word that might throw you off when you're getting a loan. First-time home buyers often make the mistake of thinking that each loan payment will pay off the same amount of interest and principal. Unfortunately, banks aren't willing to do it this way, so we have to talk about amortisation.
With amortisation, the lender usually puts almost all of your first mortgage payments toward the interest you owe on the loan. If your loan requires monthly payments of $1,000, $900 of your first payment might go to interest and $100 to the principal. As time goes on, the amount you pay toward the principal will go up. Yes, it is maddening.
