Once you start speaking with mortgage lenders, realtors, and even friends about buying a home, you might feel like you’re swimming in an unfamiliar pool of abbreviations and terms you’ve never heard before. We’re defining some of the most common terms here, so you learn to tell your PMI from your DTI.
Adjustable-Rate Mortgage (ARM)
This type of mortgage loan has a rate that changes at periodic intervals. Changes to the mortgage rate are usually based on fluctuations in the prime interest rate. Each financial institution sets this interest rate based on the federal funds rate—the rate financial institutions charge each other when they lend money. When you have an ARM, your monthly payments may change quarterly, twice a year, or annually. This type of loan may be recommended when rates are stable or predicted to drop for an extended period, but they may not be desirable in a period of rate increases.
Amortization is the process of paying a loan off over a period of installments. Each installment pays a certain amount toward the principal and another amount toward the interest. When you first begin paying a mortgage, the bulk of your monthly payment covers the interest, and a small amount goes toward the principal. As you pay down the principal, the proportion of each payment that goes toward the principal increases.
An appraisal is essential when using a mortgage to buy, sell, or refinance a property. It is a home valuation prepared by a professional appraiser. The appraiser will determine this value based on the condition of the home, recent sales of comparable homes (often called comps), and the overall housing market in your area.
This amount is a large payment due at a specified point during the loan or at the end. These payment arrangements are not common now, but they are a loan feature to look out for.
As the last step in the buying process, the closing is the formal settlement of the sale and the loan. You will sign papers to take ownership of the home and agree to the final terms of your loan.
Closing costs are fees associated with the sale of the house, such as title insurance, realtor commissions, appraisal fees, home inspection fees, loan origination fees, taxes, credit report charges, and deed recording fees. The seller pays some fees, and the buyer pays others. You may settle these fees with cash at the time of closing, or they may be rolled into the loan, increasing the amount of money you borrow.
Contingencies are part of the real estate contract. They state the conditions that each party must complete before the sale of the home. These contract clauses might include a requirement that the buyer is able to sell their current home before closing on the home they are buying or repairs the seller must complete before closing. Both the buyer and seller must agree to all contingencies.
Debt to Income Ratio (DTI)
A DTI is the ratio of your monthly debt payments (mortgage, auto loans, credit cards, etc.) to your overall income. Most mortgage lenders look for a DTI of less than 36%.
This payment is the amount of money you will pay toward the purchase of your house. Depending on the type of loan you are getting, you may have no down payment, or you may choose to pay up to 20% of the home’s purchase price. Your down payment reduces the amount of money you need to borrow.
Equity is the value of your home minus the amount owed. When you first buy a home, you have little equity, unless you were able to buy the house at less than market value. As you live in your home, your equity tends to increase both because you are paying down the loan and because home values tend to rise over time.
You will come across the term escrow in different phases of your mortgage. First, the escrow company, a neutral third party, will hold the seller’s property and the buyer’s good faith money until both parties meet the conditions of the sale. Then once you purchase the home, you will likely have an escrow account that holds the money to pay your home insurance and property taxes. A portion of your monthly mortgage payment will go into your escrow account, and the manager of that account will pay the home insurance and taxes when they are due. Your lender will review your escrow account each year to ensure that your monthly payments are sufficient to cover those expenses with a cushion in case of unplanned increases. If your escrow account payments aren’t deemed sufficient for the coming year, you typically have the option of increasing your monthly payment or making a one-time payment to cover the shortfall.
The interest rate on your mortgage will remain fixed for the entire mortgage period. This type of mortgage offers payment stability, particularly in times of rising rates. However, an ARM may be a more prudent option in times of falling rates.
Good Faith Money
Also called earnest money, this is a deposit the buyer offers to show they are serious about purchasing the home. The escrow company holds this amount until the completion of the sale.
When purchasing a newly built home, the developer may offer a warranty to cover repairs during a specified period.
Most mortgage lenders require an inspection to ensure that the home is physically sound. The inspector will be looking for safety issues and major and minor defects that may affect the structure of the home. For example, an inspector may find evidence of leaks and dry rot that an appraiser would not see.
Loan to Value Ratio (LTV)
The LTV is the ratio of the amount owed on your home to its overall value. If you pay a 10% down payment, you are likely to have an LTV of 90% when you move in.
This fee is the amount your lender may charge if you pay a loan off early. The prepayment penalty is not a standard feature, especially on mortgage loans. Still, you should carefully read the disclosures to ensure that there is no penalty for paying your mortgage off early.
Pre-qualification is the process of having a mortgage lender assess your creditworthiness and the amount of loan you can afford.
Private Mortgage Insurance
If you have an LTV higher than 80%, you may be required to pay monthly private mortgage insurance. Lenders require this insurance against you defaulting on the loan. You will typically pay this insurance until your LTV reaches 80% or lower, but if your home value increases before hitting that mark, you may petition to have the PMI payments halted.
This process is the final evaluation and approval of your loan by your lender. The underwriters may ask for more documentation as they assess your finances, so be in contact with your lender throughout the process so you can provide necessary information quickly.
These are many things to remember, but you can bookmark this page or print it out to refer to when your realtor or lender mentions an unfamiliar term.
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