Mortgage lenders often sound as if they’re speaking a different language, especially to those who haven’t been through the home-buying process before. It’s important to understand the terminology when preparing to undertake a mortgage for the first time.
Here are some of the most important terms you might come across while you are shopping for a home loan.
1. Adjustable-rate mortgage (ARM)
Most mortgages are fixed rate, meaning that they have an interest rate that stays the same for the entire loan term. However, there are also adjustable-rate mortgages that have a rate that stays the same for a few years and adjusts periodically thereafter. For example, a 5/1 ARM (the most popular type) has the same interest rate for the first five years, and it can adjust according to a certain benchmark every year after that.
2. Annual percentage rate (APR)
Many home buyers focus on their interest rate, but the annual percentage rate, or APR, is a better indicator of the true cost of borrowing. It includes the interest you pay, as well as any origination charges or points you pay to get the loan. For this reason, the APR is usually higher than the interest rate of the loan.
3. Appraisal
An appraisal is an assessment of your potential home’s value performed by a licensed third-party professional. This is typically required by lenders to ensure that the home you are planning to buy justifies the amount of the loan.
4. Closing costs
When you get a mortgage, you’ll have to pay certain expenses at closing. This can include a mortgage origination fee, title insurance, credit reporting fees, local taxes, and more. Closing costs can vary depending on your situation, but typically are in the range of 1% to 3% of the home’s selling price.
5. Conventional mortgage
A conventional mortgage is one that is not guaranteed by any government agency like the FHA, VA, or USDA. These loans have to meet standards set by government-sponsored enterprises Fannie Mae and Freddie Mac, though.
6. Debt-to-income (DTI) ratio
Your DTI ratio is your debts divided by your gross income, expressed as a percentage. Generally, lenders want to see your debts (including the new mortgage) as 36% or less of your income, although there is some flexibility.
7. Earnest money
Earnest money is a deposit that you submit when signing a purchase contract to demonstrate your commitment to the sale. If you terminate the contract, and don’t have a valid reason as defined by the contract, the earnest money can be forfeited and paid to the seller.
8. Escrow
When buying a home, your lender will typically open an escrow account on your behalf to keep some money separate, and each month a part of your payment will be deposited into the account to ensure that when your annual property tax and homeowners insurance bills are due, there will be money available.
9. FHA loan
An FHA loan is a type of mortgage that is guaranteed by the Federal Housing Administration. It is designed to allow people without excellent credit scores or large down payments to obtain home financing with competitive interest rates.
10. Home inspection
When you sign a purchase contract, you’ll typically have a certain number of days to do whatever due diligence you deem necessary. A home inspection (performed by a licensed professional) is usually the first thing you’ll do, and it can reveal any issues with the home that you should know.
11. Loan-to-value ratio
The LTV ratio is a metric that calculates the balance owed on your mortgage as a percentage of your home’s value (usually defined as the purchase price initially). For example, if you use a $300,000 mortgage to buy a home for $400,000, your initial LTV ratio will be 75%.
12. Mortgage insurance (or PMI)
If you put less than 20% down on a conventional loan, you may pay for mortgage insurance. This protects your lender in the event that you cannot make the payments on your loan. FHA loans have their own mortgage insurance, called MIP.
13. Mortgage servicer
Many first-time home buyers are surprised to find out that the lender that originated their mortgage loan isn’t necessarily the company they’ll make payments to after closing. A mortgage servicer handles the month-to-month administrative work behind your loan, including collecting payments and making sure your taxes and insurance get paid in a timely manner.
14. Origination fee
Most lenders charge an origination fee, which is their charge for facilitating your mortgage loan. Origination fees can vary significantly between lenders, so it’s important to shop around.
15. PITI
PITI stands for principal, interest, taxes, and insurance, and are the four components of most homeowners’ mortgage payments. Your payment might also include homeowners association (HOA) dues or other fees.
16. Title insurance
When you buy a home, the seller transfers legal ownership (title) to you. Title insurance is a major component of closing costs and provides protection in the rare event that ownership is disputed after closing.
17. USDA mortgage
USDA mortgage loans are guaranteed by the U.S. Department of Agriculture. These are designed to provide 0% down financing with relatively low interest rates to buyers who purchase a home in certain rural areas.
18. VA mortgage
A VA mortgage, or VA loan, is a type of mortgage that is guaranteed by the Department of Veterans Affairs (VA) and is offered to qualifying veterans, military members, and their families.
The bottom line on mortgages
By understanding what these terms mean, you’ll be in a great position to approach the mortgage process with confidence, and to make the best decisions for you and your family. This isn’t an exhaustive list, so it’s a smart idea to learn as much about the mortgage process as possible before you get started.
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