The price of the average home in the U.S. is so high that few people have enough cash to buy one outright. Instead, most prospective homeowners finance the purchase. The term home loan by definition refers to money that is borrowed to purchase property and paid back in monthly installments over the course of many years. The lender profits from the loan by charging interest that’s added to the original amount borrowed.
A home loan, also referred to as a mortgage, is money borrowed to finance the purchase of a home.
Mortgage and Home Loan Definition
A loan that’s used to purchase a home is commonly known as a mortgage. The lender may be a bank or mortgage company. A mortgage typically has four components:
- Principal refers to the original amount of money borrowed. It may be less than the purchase price of the home. Real estate experts recommend borrowing 80 percent or less of the value of a home and using savings for the remainder, also known as the down payment.
- Interest is the amount charged by the lender for use of the borrowed money. It accrues over time until the loan is paid off.
- Property taxes are charged by a local government agency and paid by the homeowner. They typically cover water and sewer infrastructures, police and fire services and other services that benefit the homeowner.
- Homeowners insurance must be purchased by the homeowner to cover the lender’s investment. Some lenders also require mortgage insurance coverage from borrowers who don’t make a sizable down payment.
Home Loan Collateral
With a home loan, the purchased real estate becomes collateral for the loan, meaning the lender has a legal claim on the property and can seize it through the foreclosure process if the borrower falls too far behind on loan payments. Under federal law, the lender has the right to start foreclosure once a homeowner is more than 120 days (or three months) behind in mortgage payments. Secured loans like mortgages and auto loans provide more security for the lender and more risk for the borrower.
Home Loan Providers
Mortgages are available from a variety of financial institutions. Besides banks and credit unions, there are lending companies like Quicken Loans and PennyMac Financial. Some of these companies allow you to get a mortgage online through a simplified application process. Mortgage brokers are another source for home loans. These services work with a variety of lenders to find the most suitable loan for individual borrowers.
The federal government sponsors a few types of special mortgages, each with its own set of rules and restrictions:
- FHA home loans are guaranteed by the U.S. Federal Housing Administration. They allow first-time homebuyers and others to make smaller down payments.
- USDA home loans are available for rural homeowners from the U.S. Department of Agriculture. No down payment is required for those who qualify.
- VA home loans are available for veterans of U.S. military service, who are given the benefit of being able to get home loans with no down payment, a low interest rate and no mortgage insurance requirements.
Types of Mortgage Interest
There are two main types of mortgage interest. Fixed-rate mortgages use an interest rate that stays constant for the life of the loan, making the amount of monthly payments predictable. This is the most popular type of mortgage. When interest rates fall below the loan’s interest rate, the borrower may be able to refinance the loan at a lower interest rate.
Adjustable-rate mortgages (ARMs) start with a low interest rate that is adjusted after a period of time. The adjustment is based on a market index, so it is somewhat unpredictable. Borrowers who want a lower initial interest rate who don’t plan to keep the property for many years can benefit from an ARM since the monthly payment can rise significantly during the lifetime of the loan.
Catie Watson spent three decades in the corporate world before becoming a freelance writer. She has an English degree from UC Berkeley and specializes in topics related to personal finance, careers and business.