The generic definition of a purchase loan is "a loan taken out by a consumer to make a purchase." In the real estate world, a purchase loan is a mortgage taken out to buy a house. The term is used to differentiate from home equity loans (also known as second mortgages); refinance loans, which are new mortgages on a home that replace the original; and home equity lines of credit - or HELOCs.
Purchase loans, or new mortgages, are available in a frightening array of options, payment methods and interest schemes. They come with an assortment of fees, charges and cash layouts with other names that taken together are known as closing costs. Before you are through, the closing costs on your mortgage will run in the thousands of dollars. For that reason, some purchase loans are available that include money to cover the closing costs.
The two basic types of purchase loans are the fixed rate mortgage and the adjustable rate mortgage. Each has its own set of advantages and disadvantages. A thirty year, fixed rate mortgage was the traditional purchase loan for much of the last century. Loans of this type (and simplicity) usually require a 20% down payment on the house, although not all lenders require that anymore. However, a purchase loan that is taken out with a 20% down payment will allow the borrower to avoid personal mortgage insurance (PMI) which can add one hundred dollars or more to your monthly mortgage payment. That insurance is required until such time as the borrower owns a 20% interest in the home.
Adjustable rate purchase loans are designed to make it a little easier for homeowners to crack the housing market. They carry a low interest rate for the first period of the mortgage, typically 3; 5; 7 or 10 years. After the initial period, the interest rate rises based on a formula that involves an index - a figure taken from a money market such as the interest on a one year Treasury bill - and a margin, which are percentage points added on to the index in order to establish the new interest rate on the loan. Adjustable rates on purchase loans are reset annually.
Purchase loans are available that finance 100% of the property, with no down payment involved. The corresponding interest rates are extremely high, however. More often, people will combine a purchase loan with a 5% or 10% down payment. There is also the option of taking out an additional loan (called a piggyback loan) that will allow the borrower to plunk down a 20% down payment. This practice eliminates mortgage insurance requirements and, in theory, results in a better interest rate on the principal purchase loan.