Arrange your finance and get ready to buy

Most buyers borrow part of the price. After this lesson, you will understand how a home loan works and how to compare loan offers.

You will also know how to prepare your paperwork and get an early answer from a lender, so you can search with confidence.

How a home loan works

A home loan is money a lender gives you to buy a property. It is often called a mortgage, a home loan or a bond. You repay it in regular payments over many years, usually every month.

The property is normally used as security. Security, also called collateral, means the lender can take and sell the property if you stop making payments. This is why you should only borrow what you can repay.

Each payment usually has two parts. One part pays back the money you borrowed, called the principal. The other part is interest, which is the price the lender charges for lending you the money.

Types of interest rate

Loans often come with one of two main types of interest rate. A fixed rate stays the same for an agreed period. Your payments are predictable during that time.

A variable rate, also called a floating or adjustable rate, can go up or down. Your payments may fall, but they may also rise. Ask each lender exactly how and when their rate can change.

Some lenders also offer finance that follows different rules, for example to meet religious principles. Ask lenders which types of finance they offer.

Comparing loan offers

Do not compare loans by the interest rate alone. Look at the total cost over the whole loan. Ask each lender these questions:

• What is the total amount I will repay, including all fees?
• How long is the loan, and what is the monthly payment?
• Can the rate change, and if so, how?
• Is there a charge if I repay early or move to another lender?
• What happens if I miss a payment?

Ask for the answers in writing. An independent financial adviser or a mortgage broker, a person who compares loans from many lenders, can help you understand your options. Ask how they are paid, so you know if anything might affect their advice.

Preparing your paperwork

Lenders want proof that you can repay. Gather your documents early, so you are not rushed later. The exact list differs by lender and country, but it often includes:

• Proof of identity and address.
• Proof of income, such as payslips, a work contract or business accounts if you work for yourself.
• Bank statements for recent months.
• Details of any debts, such as credit cards or car loans.
• Proof of where your deposit money comes from.

Lenders often check your credit history. This is a record of how you have repaid money in the past. Paying bills on time and reducing debts before you apply can help.

Getting an early agreement

Many lenders can give you an early answer before you find a property. This is called an agreement in principle, a decision in principle or a pre-approval. It shows roughly how much the lender may lend you.

An early agreement is not a final loan offer. The lender will still check the property and your details later. But it shows sellers and agents that you are a serious buyer, and it keeps your search within budget.

Once you have one, you can start browsing property for sale in your price range. If you are buying from abroad, or with money earned elsewhere, ask lenders early whether they can help, because the rules can be very different.

Common mistakes

• Choosing a loan on the interest rate alone. Avoid this by comparing the total cost, including all fees and charges.
• Applying to many lenders without thinking. Avoid this by asking each lender whether their check affects your credit history.
• Leaving paperwork to the last minute. Avoid this by gathering your documents before you start viewing properties.

Key points

• A home loan is secured on the property, so only borrow what you can repay.
• Compare loans by their total cost, not just their interest rate.
• An early agreement from a lender helps you search with confidence, but it is not a final offer.