How Do You Finance a Home?

Presuming you do not have a very large supply of cash on hand, you will have to finance your home with a mortgage. A mortgage loan is essentially a secured loan that uses the home as collateral. Mortgages are typically paid in monthly installments over several years—usually 15 or 30 (40-year mortgages do exist, but they are not offered by every lender).

Mortgages contain two distinct parts:

Principal. The amount you need to borrow to pay for your home and closing costs.
Interest. What you pay the financial institution for the use of its money.

Your monthly payments will be based on an amortization schedule in which the percentage of each payment that goes to interest gradually decreases as your equity in the property increases.

You can also select between a fixed-rate mortgage—locking in your interest rate for the life of the loan—and an adjustable-rate loan, one in which the interest rate may fluctuate from year to year. There are advantages and disadvantages to each. You need to compare the rates and make a guess of how future rates will move, as well as how long you plan to stay in that same home.

The percentage of each payment that goes to interest gradually decreases as your equity in the property increases.

Lower loan rates often require that points be paid up front. A point equals 1% of the loan's principal and represents pre-paid interest.

Balloon financing is another way to decrease your monthly payment. Basically, this type of financing offers a below-market interest rate for a predetermined amount of time, with a balloon payment (the balance of the loan) paid at the end of the term.

Interest-only loans have become popular in recent years. They are a variation on balloon financing and resemble how a bond works. With an interest-only loan, the borrower pays only the interest on the loan each month. At the end of the loan term, the borrower repays all the principal. The advantage of an interest-only loan is that the payments are lower than those of a regular amortized loan. Because no principal is paid each month, buildup in equity is slower, and if the property value declines, the borrower may be faced with insufficient equity to repay the principal. Interest-only loans may be fixed, but are usually offered as variable-rate loans.

In order to know how much home you can afford, you will want to be pre-approved by your lender. In the pre-approval process, your lender will examine your gross monthly income and your long-term debt, using a set of loan ratios.

For instance, to figure your total loan amount, a lender will calculate 33% of your monthly income and subtract your monthly long-term debt (loans, credit cards, car payments, etc.). That number will be compared to 25% of your gross monthly income. The lower of the two numbers will be considered the maximum monthly mortgage payment you can afford. The total amount you can borrow will be calculated from that figure.

1. Currency and coins. Cash is also known as legal tender. 2. The currency, coins, bank balances, and (negotiable) money orders and checks that a business owns.

To raise money by selling stocks, bonds, and other notes. In economics, finance is the practice of extending credit and backing ventures, both with the purpose of making money.

A loan to buy real estate property, usually secured by the real estate property itself.

A loan guaranteed by assets such as stocks, bonds, jewelry, real estate, etc.

Property offered to be given up in case a loan cannot be repaid. For example, when taking out a loan from a bank, the customer may put up a house, a car, or cash as collateral.

What one must pay for materials, services, and other necessities to operate a business, organization, or household.

The medium of exchange used in trade or commerce.

A schedule for paying back a loan, showing how much of each payment goes toward interest and toward principal.

A charge for using another's money. Interest is usually stated as a percentage of the amount borrowed and can be charged in a variety of ways, such as accrual, compounding, or simple interest.

1. Total assets minus liabilities. 2. The net worth of a company. 3. The amount of a company one owns according to how much stock he or she has. 4. The value of a property minus its liens.

A mortgage with an interest rate that remains unchanged over its life.

A percentage that indicates what borrowed money will cost or savings will earn. An interest rate equals interest earned or charged per year divided by the principal amount, and expressed as a percentage. In the simplest example, a 5% interest rate means that it will cost $5 to borrow $100 for a year, or a person will earn $5 for keeping $100 in a savings account for a year.

Money that has been borrowed from a creditor (lender) by a debtor and that must be repaid. Loans may also be referred to as liabilities.

A loan in which the interest rate may change from one period to the next.

1. The percentage of a loan's principal paid in advance as pre-paid interest. 2. The measurement unit used to report prices of securities. In stocks, it is $1. In bonds, it is $10. In commodities, it can be any convenient fraction.

1. The amount borrowed, or the part of the amount borrowed that remains unpaid (not including future interest). 2. The part of a monthly payment that reduces the outstanding balance of a mortgage or other loan. 3. The original investment amount of a security. 4. In banking terms, principal is the original deposit or loan on which interest is earned or paid.

A type of financing that offers low payments for a predetermined period and a large balance payment made at the end of the term.

The remaining balance of a loan paid at the end of the loan term.

1. The amount of money in an account. 2. To match revenues and expenses in a budget so that their sum is zero. 3. To compare personal check records with the checking account statement one's financial institution sends periodically, to make sure the amounts match, or balance. Also known as reconciling the checking account.

A borrowing arrangement in which the borrower pays back only the cost (interest) and not the principal during an agreed-upon term, after which the principal is paid.

A legal document that is a promise to repay borrowed principal along with interest on a specified schedule or certain date (the bond's maturity). Federal, state, and local governments, corporations, and other types of institutions raise capital by selling bonds to investors.

Total sales or income, before deductions are made.

The monetary return on one's labor or investments. Income may be wages, salaries, bonuses, dividends, or interest.

Loans and other obligations that last longer than one year.

Number relationships between two things, used to indicate the strength of each against the other. A ratio is obtained by dividing one number by another. Price to earnings (P/E), for example, is a commonly used ratio in stocks.

A plastic card that allows the owner to borrow money or buy products and services on credit with his or her signature. The lender that issues the credit card puts a dollar limit on its use, depending on the borrower''s creditworthiness.

How Do You Finance a Home?

Home Ownership