Mortgage Basics: How Home Loans Work Before You Apply
Rates, terms, down payments and the hidden costs of buying a home — explained simply, with the numbers lenders use.
Key takeaways
- Your payment depends on loan amount, rate and term — rate is where shopping around pays.
- Lenders look at debt-to-income; keep total debts around or below 36% of gross income.
- A bigger down payment lowers both the payment and, often, the rate.
- Budget 2–5% of the price for closing costs on top of the down payment.
How a mortgage works
A mortgage is a loan secured by the property you buy. Each monthly payment covers interest plus a slice of principal. Early payments are mostly interest; later payments are mostly principal. This schedule is called amortisation — you can see it year by year in our mortgage calculator.
Key terms
- Principal: the amount borrowed.
- Interest rate / APR: the cost of borrowing; APR includes certain fees.
- Term or amortisation period: how long you take to repay — commonly 15–30 years.
- Fixed vs variable (floating): fixed keeps the rate constant; variable moves with a benchmark rate.
- Down payment: your upfront share of the price. Small down payments often require mortgage insurance.
- LTV (loan-to-value): loan ÷ property value. Lower LTV usually means better terms.
How lenders decide what you can afford
Most lenders apply two ratios. The housing ratio keeps housing costs near 28–32% of gross monthly income. The total debt ratio keeps all debt payments near 36–44%. Your credit score, employment history and savings also matter. Our affordability calculator applies these ratios to your numbers.
Why the rate matters so much
On a 400,000 loan over 30 years, the difference between 6.0% and 6.5% is about 130 a month and roughly 47,000 over the life of the loan. Getting quotes from at least three lenders on the same day is one of the highest-value hours you'll ever spend.
Costs beyond the down payment
- Closing costs: legal, appraisal, title, registration and lender fees (often 2–5% of the price).
- Property taxes and homeowner's insurance.
- Maintenance — a common rule of thumb is 1% of the home's value per year.
- Stamp duty or land transfer tax in many countries and states.
Steps to a strong application
- Check your credit reports and fix errors 3–6 months ahead.
- Pay down card balances to lower utilisation and your debt ratio.
- Save the down payment plus closing costs plus a cash cushion.
- Get pre-approved so you know your real budget before house-hunting.
- Compare offers by APR and total cost, not just the headline rate.
Watch: the 5-minute version
FAQ
How much down payment do I need?
It varies by country and loan type — from about 3–5% for some insured or government-backed loans to 20% to avoid mortgage insurance in many markets. Indian lenders typically finance 75–90% of the property value.
Fixed or variable?
Fixed suits buyers who value predictable payments. Variable can be cheaper when rates fall but exposes you to increases. Your budget's ability to absorb a higher payment is the deciding factor.
Does pre-approval hurt my credit?
It usually involves a hard inquiry, which can lower a score slightly. Multiple mortgage inquiries within a short shopping window are often treated as one.
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This guide is general education, not personal financial, tax or legal advice. Rules, rates and limits vary by country and change over time — confirm with official sources or a licensed professional.