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Mortgage Terms and Definitions You Should Know
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage (ARM) is a type of loan with an interest rate that varies depending on how market rates move. When you sign up for an ARM, you first get a short period of fixed interest. This is the introductory period of the loan and can last for up to 10 years. During your introductory period, your interest rate is usually lower than what you’d get with a fixed-rate loan. After the introductory period expires, your interest rate will follow market interest rates. ARMs have caps in place that limit the total amount that your interest can rise or fall over the course of your loan.
Amortization
Home loan amortization is the process of how payments spread out over time. When you make a payment on your mortgage, a percentage of your payment goes toward interest and a percentage goes toward your loan principal. In the beginning of your loan, your principal is high and most of your payment goes toward interest. However, you chip away at your principal over time and pay less in interest. An amortization schedule can reflect consistent monthly payments and keep you on track to pay off your loan within the term.
Annual Percentage Rate (APR)
Annual percentage rate (APR) is the interest rate you’ll pay on your loan annually plus any additional lender fees. You’ll usually see APR expressed as a percentage. You may see two interest rates listed when you shop for a loan. The larger number is always your APR because it includes fees.
Appraisal
An appraisal is a rough estimate of how much your home is worth. Mortgage lenders require that you get an appraisal before you sign on a home loan. The appraisal assures the lender that they aren’t loaning you more money than what your home is worth. Your lender may help you by scheduling an appraisal, done by an independent third party.
Assets
In the context of a mortgage, an asset is anything that you own that has a cash value. Some examples of assets include:
- Checking and savings accounts
- 401(k) and IRA accounts
- Certificates of deposit (CDs)
- Stocks
- Bonds
- Mutual funds
When you apply for a mortgage, your lender will want to verify your assets. This is to ensure that you have enough money in savings and investments to cover your mortgage if you run into a financial emergency.
Balloon Loan
A balloon loan, or balloon payment mortgage, gets its name from the large size of its payments. It’s a type of financing that requires a lump sum to be paid at some point in the mortgage term – most commonly, at the end. With a balloon loan, you choose to pay an interest-only mortgage or one that includes both principal and interest payments. Interest-only mortgages only require you to pay the cost of interest throughout your term with the entire balance due at the end.
Closing Costs
Closing costs are settlement costs and fees you pay to your lender in exchange for finalizing your loan. Some common closing costs include appraisal fees, loan origination fees and pest inspection fees. The specific costs you’ll need to cover depend on your location and property type. Closing costs usually equal 3% – 6% of the total value of your loan.
Closing Disclosure
A Closing Disclosure is a document that tells you the final terms of your loan. This document includes your interest rate, loan principal and the closing costs you must pay. Your lender is legally required to give you at least 3 days to review your Closing Disclosure before you sign on your loan.
Debt-To-Income (DTI) Ratio
Your DTI is equal to your total fixed, recurring monthly debts divided by your total monthly gross household income. Mortgage lenders look at your DTI when they consider you for a loan to make sure that you have enough money coming in to make your payments. You may have trouble finding a loan if your DTI is too high. Most lenders cater to applicants who have a DTI of 50% or lower.
Deed
A deed is the physical document you receive that proves you own your home. You’ll receive your deed when you close on your loan.
Discount Points
Discount points are an optional closing cost you can pay to “buy” a lower interest rate. One discount point is equal to 1% of your loan amount. The more discount points you buy, the lower your interest rate will be. However, if you buy more points, you’ll need to cover them in cash at closing. You’re essentially paying more up front to enjoy more savings over the life of the loan.
Down Payment
Your down payment is the first payment you make on your mortgage loan. You’ll usually see your down payment listed as a percentage of your loan value. For example, if you have a 20% down payment on a $100,000 loan, you’ll bring $20,000 to closing. Most loan types require a down payment.
Though many people believe that you need a 20% down payment to buy a home, this isn’t true. You can buy a home with as little as 3% down. Some types of government-backed loans may even allow you to buy a home with no down payment.
Earnest Money Deposit
An earnest money deposit is a check that you write to a seller when you make an offer on a home. Most earnest money deposits are equal to 1% – 3% of the home’s value. An earnest money deposit tells the seller that you’re serious about buying their home. If the seller accepts your offer, your earnest money deposit goes toward your down payment at closing.
Escrow
Most people who have a mortgage have an escrow account where their lender holds money for property taxes or homeowners’ insurance. This allows you to split taxes and insurance over 12 months instead of paying it all at once. Your lender may add escrow payments to your monthly mortgage dues along with principal and interest payments.
Fixed-Rate Mortgage
A fixed-rate mortgage has the same interest rate throughout the term of the loan. For example, if you buy a home at 4% on a 15-year fixed-rate loan, it means that you’ll pay 4% interest on your loan every month for your entire 15-year term. Homeowners who choose a fixed-rate term often believe that rates will rise over the course of their loan and want the stability and predictability this type of loan provides.
Home Inspection
A home inspection is different from a home appraisal. An appraisal gives you a rough estimate of how much a home is worth, but an inspection tells you about specific problems in the home. An inspector will walk around the home you want to buy and test things like the heating and cooling system, light switches, and appliances. They will then give you a list of everything that needs to be repaired or replaced in the home. Most mortgage lenders don’t require an inspection as a condition of getting a loan, but it’s a good idea to get an inspection to make sure that your home doesn’t have any pressing issues before you buy it.
Homeowners Insurance
Homeowners insurance is a type of protection that compensates you if your home gets damaged during a covered incident. Common damages that are covered include fires, burglaries, and windstorms. In exchange for coverage, you pay your insurance provider a monthly premium. You’re not legally required to get homeowners insurance to own a home. However, your mortgage lender may require you to maintain at least a certain level of coverage for the life of your loan.
Preapproval
A preapproval is a document that tells you how much you can afford to take out in a home loan. Many lenders consider the preapproval to be the first step in getting a mortgage. When you apply for a preapproval, your lender will ask you about things like your credit score, income, and assets. Your lender will then use this information to tell you how much you qualify for in a home. This can give you a rough budget to use when you compare properties.
Keep in mind that a preapproval isn’t the same thing as a prequalification. Prequalification usually don’t involve asset and income verification, which means that they aren’t as reliable as preapprovals. Make sure you get a preapproval before you begin shopping for homes.
Principal
Your principal balance is the amount that you take out in a loan. For example, if you buy a home with a $450,000 loan from your lender, your principal balance is $450,000. Your principal balance shrinks as you make payments on your loan over time.
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is a type of insurance that protects your lender if you default on your loan. Your lender will usually require you to pay PMI if you have less than a 20% down payment. You have the option to remove PMI from your loan when you reach 20% equity in your property.
Property Taxes
You’ll be required to pay property taxes to your local government. The amount you pay in property taxes depends on your home’s value and where you live. Property taxes fund things like police departments, roads, libraries, and community development. Don’t forget to factor in property taxes when you shop for a home.
Real Estate Agent
A real estate agent is a local property professional who can help you shop for a home more effectively. Real estate agents can show you homes in your price range, draw up offer letters and work with sellers to get you a great deal on a home. There are two main types of real estate agents: seller’s agents and buyer’s agents. Seller’s agents work on behalf of sellers while buyer’s agents work with those shopping for a home. In exchange for working with you, your real estate agent takes a commission from your home sale or purchase.
Refinance
Refinancing happens on an existing mortgage. Essentially, you trade the original debt obligation in for a new one. Refinancing is beneficial for borrowers to create a more convenient payment schedule, a lower interest rate or a different term. When considering refinancing on your mortgage, consider the closing costs associated with getting a new loan.
Seller Concessions
Seller concessions are clauses in your offer that ask the seller to pay certain closing costs. For example, you might ask the seller to cover things like appraisal fees or your title search. The seller can reject your concessions or send you a counteroffer with concessions removed. Limitations on the percentage of your closing costs sellers can cover varies by property type.
Term
Your mortgage term is the number of years you’ll pay on your loan before you fully own your home. For example, you may take out a mortgage loan with a 15-year term and that means that you’ll make monthly payments on your loan for 15 years before the loan matures. The most common mortgage terms are 15 years and 30 years, but some lenders offer terms as short as 8 years.
Title
A title is proof that you own a home. Your title includes a physical description of your property, the names of anyone who owns the property and any liens on the home. When someone says that they’re “on the title” of a home, it means that they have legal ownership of the property. For example, if your parents were to help you purchase a home, they’d likely be listed on the title.
Title Insurance
Title insurance is a common closing cost. You buy title insurance to protect yourself against outside claims to your property. Unlike other types of insurance, you don’t need to pay for title insurance every month. Instead, you make a single payment at closing that protects you for as long as you own the home.
Mortgages can be difficult to navigate and learning the common terminology is the first step to fully understanding your loan to complete the home buying process. When reading through hefty contracts, keep a mortgage terms glossary handy to refer to.