After several years of waiting and dreaming, you’ve started the home-buying process in earnest – and that means thinking about mortgages.
By now, you probably know that it’s wise to seek pre-approval for a loan before you even look at houses. Unfortunately, that first foray into a lender’s office may leave you feeling like you’ve just been transported to some far-off land where the language is entirely foreign.
We’ve got you covered.
17 Common Mortgage Terms You Should Recognize
When you’re looking for a mortgage, there are far too many terms that you can encounter to list them all – but here are some of the most common you’re likely to hear (and a good foundation to build on for all the rest):
1. Adjustable Rate Mortgage
Adjustable rate mortgages (ARMs) tend to be poorly understood by consumers. They generally offer very attractive interest rates for a fixed period of time – but that fixed interest rate expires after a few years and can then adjust higher or lower fairly frequently. When talking about ARMs, the first number indicates how long the interest rate is fixed, while the second number indicates how often it adjusts after. The most common ARM fixed periods are 5,7,10, and 15 years. A 5/6 ARM would, then, have a fixed interest rate for five years, then adjust every 6 months thereafter for the next 25 years.
This is how long it takes to pay your mortgage off in installments. Typically, you will find home loans that amortize over 15-year and 30-year terms, although other lengths are possible. You start out paying more interest than principal, but that reverses over time.
3. Annual Percentage Rate
The APR, or annual percentage rate, is a truer reflection of a mortgage’s total cost, expressed as a yearly rate. It includes the interest rate you’re going to pay, points and other fees that will come with the loan. It’s one of the better things you can use to compare mortgage loan offers.
4. Balloon Mortgage
While they don’t come with a flashing sign that says “buyer beware,” balloon mortgages probably should. They usually offer a very attractive, interest-only payment for a short period of time, with the balance of the loan (the “balloon”) coming due all at once. Buyers usually intend to refinance balloon payments down the line when they’re more financially comfortable. If that doesn’t happen, however, they run a serious risk of foreclosure. Balloon mortgages are not very popular anymore in the mortgage industry.
5. Closing Costs
Money paid by a buyer in connection with a mortgage loan. These fees general include, but not limited to a loan origination fee, appraisal, document prep, title fees, and attorney fees.
6. Conventional Loan
Conventional loans are loans that come directly from a bank, mortgage lender or mortgage broker. They are not guaranteed by any kind of government program, such as the Department of Veterans Affairs (VA loans) or the Federal Housing Administration (FHA loans).
7. Debt-to-Income Ratio
Probably more than anything else, this is the number one figure the lender may consider when deciding whether to extend you a loan. You figure out your debt-to-income (DTI) ratio by adding together all your monthly debts and dividing by your total monthly gross income. The lower your DTI, the better.
8. Down Payment
This is the amount of money that you have on hand to make an upfront payment on the property you want to buy. While FHA loans require only 3.5% of the total purchase price for a down payment. VA and USDA loans allow for $0, while a first time homebuyer can put as little as 3% down on a conventional loan.
9. Earnest Money
This is cash money you put on the figurative table when you make an offer on a home. Earnest money shows the seller that you’re serious. If you complete the sale, the earnest money goes toward your down payment or closing costs. If the sale falls through for a good cause, it’s returned to you. If you break the contract without good cause, you will forfeit this money to the seller.
You most likely want an escrow account. Escrow accounts are set up by mortgage lenders to pay your homeowner’s insurance and your property taxes automatically, and the escrow amount is part of your monthly payment. Without an escrow account, you’re responsible for making those all-important payments on your own.
What is “equity,” anyhow, you say? It’s the value of your property minus any existing loans (mortgages) or liens you may have.
12. First-Time Home Buyer
There’s a lot of confusion about what makes a first-time home buyer because many programs consider anybody who hasn’t bought a home within the last three years to be in that category. FTHB programs can make it easier to buy a home with low down payment requirements.
13. Fixed-Rate Mortgage
This is the type of loan most people understand the best. The interest rate is fixed when you take the loan and it doesn’t change unless you refinance some time in the future.
14. Home Appraisal
This is a formal evaluation by a professional that says exactly how much a home is worth – and it could be higher or lower than a seller’s asking price. It’s generally based on “comps,” or comparable property sales in the area within a recent period.
15. Loan Estimate
This is a three-page document that lenders are required to give you when you apply for a mortgage. It includes critical figures that apply to their offer, including your estimated interest rate, closing costs, taxes, insurance fees and your total monthly payment. You can use this to easily compare mortgage offers.
16. Private Mortgage Insurance
PMI, or private mortgage insurance, is something that most lenders require if you have less than 20% of a home’s value to use as a down payment. In essence, it helps insulate the lender in case you default (since there’s not enough equity in your property) and they have to foreclose.
17. Title Insurance
Legal issues due to an unclear deed can become an expensive nightmare – long after your purchase goes through. Title insurance can cover either the lender or the buyer, but you may be required to purchase both policies as part of your mortgage.
Is this everything you need to know about mortgages? Definitely not! That’s why you need a mortgage expert you can trust to walk you through the process. With these basics, however, you can definitely hold your own in the upcoming conversations surrounding your mortgage options.