An introduction to home loans

Home loans can be simple or quite complex. But these basics will at least introduce you to the lingo and concepts involved. Do your homework, ask questions, and do not sign anything until you fully understand it, and you'll do just fine.

Buying a home steals one's breath away the first time. The realization that your signature obligates you for tens or hundreds of thousands of dollars deters many new potential buyers. But buying a home usually serves as not only the biggest investment of your life but the smartest, too.

Home loans mystify the novice. So many options stand before you, and if you are not financially savvy, you cringe at the choices wondering which will save you money and which will put you in the poor-house.

For those in the dark about home loans and home buying, study some of the simple concepts, options and terminology beforehand to educate yourself and warm up to the idea of home financing.

Mortgage and Promissory Note - When you purchase a home, you borrow money from a lender. To consummate the deal between you and the lender, you sign a promissory note promising to pay the loan back. This document explains the details of time, interest rate and principle or money borrowed. The mortgage attaches the real estate property to the loan. If you do not pay the loan, the mortgage gives the lender the right to foreclose or take the house to pay the debt. While these look scary when they are signed, they are quite boilerplate in design with no surprises. Since they are long, ask for a blank or draft copy to study in advance.

Down payment - Expect to pay 5 to 20 percent of the contract price as a down payment. The type of loan, the lender and your credit determine how much is minimally required. You can always pay more down, but you cannot pay less without the lender's approval. Occasionally you find loans without down payments such as with the US Department of Agriculture, the Veteran's Administration, and some state programs for first-time homeowners in specifically defined geographic areas.

Interest rates - If you and your neighbor each borrow $100,000 for a house, the principle you pay is the same - $100,000. However, if you get a loan at 6% and your neighbor gets one for 5%, your payments will be different due to the interest. The 6% loan will have a $600 monthly payment while the 5% loan will have a $537 payment. Shopping for interest rates is smart and can represent lots of money. Over the life of a thirty-year loan, your 6% rate loan amounts to $216,000 or $116,000 in interest. The neighbor's 5% loan amounts to $193,320 or $93,320 in interest. You pay $22,680 more over thirty years due to that 1% difference.

Fixed rates - This is a loan calculated over a number of years with even payments. The principle and interest for these loans do not change for the 15, 20 or 30 years. When interest rates are very low, obtaining a long-term fixed loan is a wise move and often a great investment.

Flexible rates - These loans have payments that vary. Flexible rate loans come in many shapes and sizes. Some are called ARM - adjustable rate mortgages - with the payment floating usually a year at a time. These loans have caps or ceilings on them to avoid the disastrous effects of sudden interest rate increases, but the homeowner needs to be flexible in his budget to accommodate the annual changes. The example above gives you a good indicator of the difference 1% interest can make.

Interest-only loans - Be careful with these. These loans make affordability easier and even allow you to buy a larger and more expensive home. But remember you are only paying on the interest and not on the principle or initial cost of the house. Study these loans well because sooner or later you have to pay on the principle of the loan and that often means much larger payments downstream.

Escrow - This is a bank account used for collecting and distributing money. Escrows are used by loan closing agents to pay sellers, insurances, banks and whoever receives proceeds from the sale of a home. Escrow can also represent the account at the mortgage company who gave you your loan. This account collects money from you for real estate property taxes and insurance.

Real estate taxes - When you buy real property like houses and land, the local governmental authority usually assesses a value to the property and collects a tax according to that value. Some lenders will let you pay the annual taxes yourself, but if you are a first-time homeowner or have limited assets, a mortgage company will require that they collect the annual taxes in a monthly, prorated amount.

Homeowners insurance - To own a home, you must have insurance. Lightning, fire, flood, and even burglary or injury liability are reality, and you need insurance to cover the major expenses that can result from such calamity. Your mortgage company will usually collect this expense in a monthly manner like the real estate taxes.

Closing costs - Many first time shoppers underestimate closing costs for a loan. Each state, city and region has different fees and different requirements. Some expenses can be attorney fees, title insurance, pest inspection, recording fees, and homeowners' association fees. Before signing a contract to buy a house, obtain a detailed estimate of your closing costs. Expect to pay as much as 5% of the home's value in closing costs.

Real estate commission - The real estate agents earn a living from commissions which can range from as little as 2% to as much as 10% on rural undeveloped or commercial property. The average real estate rate is 5-7% of the house price tag. As a buyer, you do not pay this commission. However, when negotiating the price of the house, remember that the seller does have to pay this

commission, and he will use that knowledge in negotiating the final price.

Home loans can be simple or quite complex. But these basics will at least introduce you to the lingo and concepts involved. Do your homework, ask questions, and do not sign anything until you fully understand it, and you'll do just fine.

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