Home Loans

Home Loans Are Simply a Fabulous Deal for Us

Home ownership is the goal of most people, as it should be given the benefits involved. If we have the means to own our own home, we should always seriously consider it. Many people who may otherwise qualify for a home loan miss out on all the advantages of them by not fully understanding the process or the benefits of doing so, and this can have a big impact on not only your quality of life but on your future financial well-being.

Homes do require someone borrowing the money to buy it, whether it is you or someone else doing it and renting your residence to you. Just about everyone needs to live in a residence that is financed, unless you inherit it from your parents and just choose to live there for the rest of your life.

Residences cost a lot of money and very few people have that sort of money just kicking around. It can take several decades to save up enough money to buy one outright, given that we’re talking six figures or more typically. While in some areas you may be able to buy a home for less than this, it’s still more than most people have in savings, or if they did, more than they would want to put into an investment like this.

Home LoansEven very wealthy people usually finance their home purchases, including ones costing tens of millions of dollars or more. While we might think that it may not make sense for someone to borrow and pay interest when they could just buy the home with cash, we may want to invest the money instead and shoot for a higher rate of return than it would cost us to borrow the money with a home loan.

That’s not a problem all that many people have though, having to decide such things, and they usually have enough trouble coming up with enough of a down payment to get the loan and buy the home of their choice. They may instead choose to rent, but in this case, they are paying off someone else’s home loan, where the principal of the loan goes down each year and eventually gets paid off.

There are several good reasons to own your residence instead of renting it. Things like having more say in the property and not having to abide by someone else’s rules are the ones we normally think of the most, where we instead become the kings and queens of our own castles so to speak instead of a serf living under the oversight of a landlord. This term landlord actually comes from the old feudal days where landlords owned properties and their serfs were allowed to live there for a price.

A much smaller percentage of people owned land back then, and they were also the ones that had all of the wealth, with non-land owners living far less prosperous lives and being exploited by the land owners.

Things haven’t changed as much as we may think since then, other than the fact that a lot more people own land and property and are the lords over that land and property instead of someone else. Many people rent though, and in all cases, the land owner does profit financially from the arrangement, where their modern serfs pay off the loan on the property, building equity for them until they own it outright. Renters can walk away from the arrangement anytime, and into a new one, but they will always walk away empty handed and make money for a different lord instead.

It used to be that property was passed on from generation to generation, but the difference between these classes today is that the fortunate class goes out and gets a home loan, while the less fortunate ones make the payments on the loans for the owner.

Home Loans Are Also Great Investments

Home loans are unique among personal loans in that they are also represent a built-in investment which has a very nice positive return over time, comparable to stocks.

This isn’t a whole lot different in fact than you borrowing the money, we’ll say $200,000, and you are given stocks of this value for your end of it. The stocks appreciate in value over time, where years later this becomes worth $500,000 or more, and you get to pocket the returns every year, which your principal payments add to, which bestows upon us what we call equity.

A home loan is even better than this, because you not only are given an investment equal in value to the amount of the home loan, and get to keep any increase in value, and you also get to live there as well. Housing costs represent a significant part of our income, which we could give to someone to rent a place where they reap this value, or we could just keep it for ourselves by being the one taking out a home loan on it.

This makes getting a home loan a fabulous idea all around, provided that we are in a position to get one. Since this is a type of loan, which always involve a promise to repay it, we are going to need at least a decent credit history to qualify for one, even though the loan is secured by the home’s value.

If you default on your home loan, the lender will take ownership for it, so your stake in it depends entirely on your ability to meet the obligations you agreed on. This does bring up an important aspect of home loans, which is to not set your payments too high so that they may become uncomfortable if your situation changes.

Being Careful with Selecting the Terms of our Home Loans

We should always choose longer amortizations over shorter ones for this reason, if there is any question of our having difficulty managing the payments, and this involves more than just making the home loan payment. When we set your home loan payments higher than necessary, we not only increase the risk of defaulting, this may also have us borrowing some of this extra amount back for other reasons, at a higher interest rate.

This actually happens very often with people, and a simple example of this would be choosing a loan payment of $2000 a month when we could have instead chosen $1600. We can comfortably afford the $2000, but in a couple of years, we now need to spend $10,000 on home repairs. If we had set aside this $400 a month in a savings account, we’d be able to pay this out of our own pocket. Instead, we have to put it on a credit card, and while we would have saved a little in interest by having this $400 a month applied to our mortgage instead of saving it, we will pay a lot more financing these repairs at much higher rates than we pay on the home loan.

What’s worse, we now have to pay the $2000 a month for the home loan payment plus whatever the payment is for borrowing this extra money for the repairs. We may not even be able to afford both, and this is not a good situation to be in at all, especially when we are put there essentially by our own hand.

People even will do this when they have other current payments such as on loans and credit cards, where you don’t even have to wait for this to become a problem. Even if you can afford to pay both, it makes no sense to put extra money on the mortgage with its low rates instead of on a higher or much higher rate for these other loans.

People in the market for home loans don’t think about this anywhere near enough, and this is also not something that your mortgage advisor has probably thought about much either, so people are almost always just be left to decide for themselves what amortization they will end up with, and often will push the limits too much.

How fast you pay off your home loan will not depend on the maximum amount of time you are given to do it, as we can always make extra payments anyway. It only makes sense to give us control over how much and how often we pay extra, rather than painting us into a corner where at best we’ll have to incur significant costs to restructure it later if things get bad enough that this becomes necessary to save our credit or even our home.

Coming Up with the Down Payment is the Biggest Challenge

Provided that our credit is good enough to qualify for a home loan at prime rates, and we have enough income to qualify for the loan as well, we’ll next need to come up with a suitable down payment. This is the biggest obstacle to home ownership, as we know how poorly people do at saving up. Sometimes they may have their parents or other relatives gift the down payment, and lenders are fine with that, and we may even be able to borrow some of it, but the money has to come from somewhere.

Most people have to save it up themselves, which can be pretty challenging, although saving for a home by using a product that is tax-deferred such as a traditional IRA or 401(k), or if you live in a country other than the U.S., whatever equivalent your country offers, can be a great idea.

One of the big benefits of this is that it’s not so simple or easy to spend the money on something else, as the withdrawal process is more complicated with these products and there are also tax implications involved. The other big benefit is that we can save up for our down payment faster by using a savings vehicle like this, as we can contribute to it pre-tax, meaning that not only our after-tax money gets contributed, the tax we would have otherwise paid if we save with another product gets thrown in as well.

If we contribute after-tax, if for instance our employer doesn’t offer pre-tax contributions, we can still use the deduction to contribute more to the plan, although this option does require enough self-discipline to actually do it and not blow the tax savings on something else.

Once we’re ready, we’ll now have to choose the type of home loan we prefer, which comes down to not only the amortization but the rate type, with fixed and variable being the options.

Lenders do know what they are doing when they set the spread between them, and variable rates will always offer the best economic solution, but some people just prefer the greater certainty of fixed rates. This is therefore more of a personal preference, but there are still things to think about.

The most important thing to realize when we’re looking forward to buying a home and getting a home loan is how time sensitive this really is. Imagine yourself having to choose between buying your home 2 years from now or 4 years from now. Let’s say the starter homes in your market come with an average price of $200,000 right now.

Assuming a growth rate of 5%, which is pretty typical, although in some markets this can be even higher, if you buy the home in 2 years it will cost you $220,000. If you wait 4 years it will cost $240,000. Waiting the two years when you could have avoided doing so just cost you an extra $20,000, and hardly anyone considers this properly.

This is actually worse than it may appear, as the person who waits the extra 2 years pays $20,000 more, but the person who did not wait not only did not have to pay this extra amount, their decision actually gained them $20,000 in wealth instead. The difference in this example is therefore actually $40,000, and it’s certainly better to collect $20,000 in two years rather than to pay it out.

There’s also the money that we are paying in rent which could have gone toward paying down our own loan rather than someone else’s, and two years of rent payments adds another $20,000 or more to the equation and add to the overall costs of waiting accordingly. This brings us up to at least being out $60,000, and probably more depending on our rent payments, just for taking our time saving up for the down payment.

Given this, if we are considering buying a home and taking out a home loan in the future, understanding all the elements involved and having a good plan to get there as soon as we can comfortably manage it goes a long way. If we instead just plod along and take quite a bit longer to get where we need to be, we not only have to wait longer to realize our dream of home ownership, it will cost us quite a bit more.

This works out to at least $30,000 per year of waiting, and this is surely way beyond what just about anyone would have guessed the amount would be, given our quite modest example. This is how big of a deal home ownership is though, and therefore this is something we should be very willing to put the time and effort into planning and executing the plan to the degree that it really deserves.

Home Loans FAQs

  • How do I qualify for a loan to buy a house?
    There are several things that lenders look at when you are looking to get a loan to buy a house. You need to have enough income to have the capacity to make the loan payments. Your credit report needs to be satisfactory to the lender. You also generally need to make a down payment to invest some of your own money into the purchase.
  • How do I get a home loan with bad credit?
    There are alternative lenders who may consider your application for a home loan in spite of bad credit. You still need to have income that they deem to be sufficient to repay the loan although this is more flexible with these lenders as well. You will pay higher or much higher rates of interest through these alternative sources.
  • How do I get a first time home owners loan?
    Getting a loan to buy your first home is fundamentally the same process as qualifying for loans for those who have had other mortgages. Lenders don’t require a mortgage repayment history, they just want to see a good history or repaying credit overall. In some areas there may be government programs to assist first time homebuyers though.
  • What kind of credit score do you need to buy a house?
    Getting a home loan through conventional lenders generally requires that your credit score be 620 or higher, which is the floor for Fannie May and a lot of banks. FHA sponsored mortgages require a score of at least 580. Alternative lenders accept lower scores but their rates also are considerably higher.
  • Is rent to own better than buying?
    It is always better to buy rather than to rent to own, as only part of your rent payments will be applied to the down payment. While you are renting to own, the property owner benefits from increases in property value rather than you. People rent to own as an alternative to just renting though and in this case renting to own can be preferable.
  • How do I qualify for a low income home loan?
    Those with low to moderate incomes, who may not otherwise qualify for a home loan through conventional sources, may qualify for government programs through organizations such as the FHA, the VA, or the USDA. Those with lower credit scores or without the ability to make a standard down payment may benefit from the more relaxed standards of these programs.
  • Can I buy a house with good credit but low income?
    One’s credit history is only one requirement to get a home loan, and having enough income to qualify for the loan is another major factor. Ultimately, if you do not make enough money to be able to handle the payments on a home loan, you won’t get it, nor would it be wise for either you or the lender because the risk would be too high.
  • Is USDA loan better than FHA?
    The USDA home loan program is more limited, and while many think that it only applies to buying homes in rural areas, it actually applies to certain regions that may include buying a home in an urban area as well. USDA loans are preferable if you do not have or want to make a down payment, where FHA loans are better suited to those with weaker credit scores.
  • What are the best first time home buyer programs?
    Some government programs like the USDA program are generally for first-time home buyers, although with some other programs like the FHA program it really doesn’t matter whether this is your first home. The goal of these programs is to have the normal standards for getting a home loan relaxed a bit to allow for more people to qualify for one.
  • Which type of home loan is best?
    Most people go with fixed rate home loans because they like the idea of not having to worry about interest rates rising in the future, resulting in higher payment amounts and even ones beyond what they may be able to afford. Variable rate home loans tend to be the least expensive on average though.
  • How can I repay my home loan faster?
    Home loans have provisions that allow borrowers to make lump-sum payments of various amounts, and paying more on your home loan will allow you to pay it off faster. It is important not to overdo this though, where you’re paying down low interest debt at the expense of not paying off higher interest debt faster, which leads to higher and not lower costs.
  • How is Home Loan EMI calculated?
    EMI, or equated monthly installments, is used to determine what payments are required to pay off your home loan or other loan over a given period of time. Calculators are readily available online which will work this all out for you. This will tell you how much you will have to pay per month to make the payments on a given sum over a given time.

References & Scholarly Articles for Home Loans

Books on Home Loans

  • Home Buying For Dummies (Author: Eric Tyson, Originally published: June 7, 1996)
  • Buying a Home: The Missing Manual (Author: Nancy Conner, Originally published: 2010)
  • The mortgage encyclopedia (Author: Jack M. Guttentag, Originally published: 2004)
John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.

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