Mortgage Terminology Explained
Confused on all of the mortgage lingo? Here's a list of common mortgage terms explained!
Mortgage Terminology Explained
One of the most important - and confusing - decisions that most people will ever make is buying or building a home and taking out a mortgage to pay for it. Many factors come in to play in determining which house is perfect for you – location, size, whether you buy or build, the number of bedrooms you need, traffic and convenience to shopping are just a few things to take into account.
But deciding on the house is not the only step in the process to getting into your dream home. Finding a mortgage to pay for your home is just as important. The decisions you make on your mortgage will have financial ramifications for years to come. Having a 30-year mortgage just a quarter of a percent lower can result in thousands of dollars of savings over the life of the loan, but rate is not the only consideration in factoring the type of mortgage you need. How much do you have to put down? How quickly to do you need to close? Are you a veteran? Is the home in the country or the city? What kind of terms do you need? A mortgage expert can help guide you in determining the best loan to meet your needs.
Common Mortgage Terms
The terminology used in discussing mortgages is unique to the lending industry and can be confusing to many people. To help take some of the confusion out of the mortgage process, we have come up with a list of some of the more commonly used mortgage terms and definitions. We hope this list is helpful to those who are looking to become new homeowners.
Adjustable Rate Mortgage - An adjustable rate mortgage (ARM) is a mortgage that has a fixed rate of interest only for a set period of time - typically one, three or five years. During the initial period, the interest rate is lower than with a fixed rate. After that initial period is over, the rate will adjust based on an index. The rate thereafter will adjust at set intervals. If rates rise, so does your interest rate. Most people who choose this type of loan typically refinance into a fixed rate once the initial term is over.
Annual Percentage Rate (APR) is the rate of interest that will be paid back to the mortgage lender, which includes the loan amount, plus interest and fees. This rate will be slightly higher than your quoted rate.
Amortization - The amortization of the loan is a schedule of how the loan is intended to be repaid. For example, a typical amortization schedule for a 15-year loan will include the amount borrowed, interest rate paid and term. The result will be a monthly breakdown of how much interest you pay and how much is paid on the amount borrowed.
Appraisal – An appraisal of the home and property is conducted by a professional appraiser, who will give an estimated value based on physical inspection and comparable houses located nearby that have recently been sold.
Bi-Weekly Mortgage - This type of mortgage has an impact on when a loan is paid and how frequently. In a typical mortgage, you make one monthly payment or twelve payments over the course of a year. With a bi-weekly payment, you are paying half of your normal payment every two weeks. This is the equivalent of making thirteen regular payments per year, which, in turn, will reduce the amount of interest you pay and result in a quicker payoff of your loan.
Closing Costs are the costs that the buyer must pay during the mortgage process. There are many closing costs involved ranging from attorney fees, recording fees, lending fees, appraiser fees and other costs associated with the mortgage closing.
Construction Mortgage - When a person is building a home, they will typically have a construction mortgage. With a construction mortgage, the lender will advance money based on the construction schedule of the builder. When the home is finished, you will need to go through another closing to get a fixed rate mortgage for the life of the loan, typically 15 or 30 years.
Construction-to-Permanent Mortgage (C2P) is a loan for a home you are building that only has one closing for the land (if needed), the construction itself and the long term financing. You may lock in a fixed rate before the home construction begins and pay interest only until the home is built. Once the final inspection is done, the loan automatically converts over to the agreed upon fixed rate and you begin making regular monthly payments.
Debt-to-income Ratio - Lenders look at a number of ratios and financial data to determine an applicant’s ability to repay a loan. One such ratio is the debt-to-income ratio. In this calculation, the lender compares the applicant’s monthly payments, including the proposed new mortgage, against monthly income. The income figure is divided into the expense figure, and the result is displayed as a percentage. The higher the percentage, the more risky the loan is for the lender, which will determine not only whether the loan is approved but also the interest rate you are quoted.
Down Payment - is the amount of the purchase price that the buyer is putting down. Generally, lenders require a specific down payment in order to qualify for the mortgage.
Equity - The difference between the value of the home and the mortgage loan is equity. Over time, as the value of the home increases and the amount of the loan decreases, the equity of the home increases. You can also increase the equity in your home by putting down a larger down payment.
Escrow - At the closing of the mortgage, the borrowers are generally required to set aside a percentage of the yearly taxes to be held by the lender. On a monthly basis, the lender will also collect additional money to be used to pay the taxes on the home. This escrow account is maintained by the lender, who is responsible for sending the tax bills on a regular basis. Homeowner’s Insurance and PMI, if applicable, are required to be escrowed as well.
Fixed Rate Mortgage - is a mortgage where the interest rate and the term of the loan is negotiated and set for the life of the loan. The terms of fixed rate mortgages typically range from 15 to 30 years, but can range from 10-40 years.
Good Faith Estimate – is an estimate by the lender of the closing costs of the mortgage. It is not an exact amount; however, it is a way for lenders to inform buyers of the approximate amount of cash they will need to pay at the time of closing of the loan.
Homeowner's Insurance - Prior to the mortgage closing date, the homeowners must secure property insurance on the new home. The policy must list the lender as loss payee in the event of a fire or other event. This must be in place prior to the loan closing.
Loan-to-value (LTV) Ratio - This calculation is done by dividing the amount of the mortgage by the value of the home. Lenders will generally require the LTV ratio to be at least 80 percent in order to qualify for a mortgage, meaning that you need to be prepared to pay 20 percent down for a conventional mortgage.
Mortgage - is the loan and supporting documentation for the financing of a home.
Origination Fee - When applying for a mortgage loan, borrowers are often required to pay an origination fee to the lender. This fee may include an application fee, appraisal fee, fees for all the follow-up work and other costs associated with the loan.
Points - are percentage points of the loan amount. Often in order to get a lower interest rate, lenders will allow borrowers to "buy down" the rate by paying points. Paying a percentage point up front in order to get a lower rate will eventually be a savings to borrowers in the long run if they stay in the house for the duration of the loan.
Principal - is the term used to describe the amount of money that is borrowed for the mortgage. The principal amount that is owed will go down as borrowers make regular payments.
Private Mortgage Insurance - When the loan to value (LTV) is higher than 80 percent, lenders will generally require borrowers to get private mortgage insurance (PMI), which is a guarantee to the lender that until the borrower reaches an 80 percent LTV, they are covered from default from the PMI provider. To get this protection, borrowers pay a monthly PMI premium.
Settlement Costs - Prior to closing, the attorneys involved in the mortgage closing will meet to determine the final costs that are associated with the loan. These settlement costs are given to all parties so that they will be prepared to pay the closing costs that have been agreed upon.
Title Insurance - The lender is using the home as collateral for the mortgage transaction. Because of this, they need to be certain that the title of the property is clear of any liens which could jeopardize the mortgage. Lenders will require borrowers to get title insurance on the property to ensure that the property is free and clear of any prior liens.
Truth in Lending - is a federal mandate that all lenders must follow. There are several important parts to the Truth in Lending regulations - including proper disclosure of rates - put in place to protect consumers from potential fraud by a lender.
Got the terminology down but curious on what your credit score means? Check out this article for how your credit score is determined!
Ready to speak with a Mortgage Originator? Contact us!