If you’re thinking about buying a house, understanding the terminology used in the world of home mortgage finance will help keep the process from feeling alien and confusing. Here’s a quick guide to get you up to speed:
The beginning of a loan application process that involves the lender verifying your employment, income, identity and credit score to estimate your potential approval for a home loan. This generates a preapproval letter you can show to home sellers to show you are a serious buyer. Preapprovals should not be confused with prequalifications, which are at best a guess based on a few pieces of unverified information.
The initial step in applying for a home loan is filling out a loan application. You can often fill this out online, or over the phone with the help of a loan officer, or LO. The information you provide in your loan application will be verified and used in the underwriting process to determine how large of a loan you may be approved for.
Your loan officer (LO) will be the point of contact in the beginning of the process. They are responsible for reviewing your loan options, advising you on loan structure and reviewing the rates and costs available to you. The Loan Officer will also help you understand the costs and fees involved and help you decide when to lock in your rate.
A transaction coordinator keeps the flow of documentation moving. This can include gathering information for verification purposes, both on the buyer and on the home being purchased.
Your loan processor is responsible for verifying all of the information submitted on your loan application, and readying your file for the underwriter. They are also in charge of clearing any underwriting conditions and getting your loan in position to order your final loan documents. The processor is often the main point of contact during the majority of the loan process after your loan is locked.
The underwriter is in charge of making the credit decision on the file and determining whether the loan meets the lending requirements for the loan program you’re applying for. The underwriter will also determine whether more documentation is needed for final loan approval or loan commitment. Underwriting is a risk management process that looks at everything from the value of the home and its condition to your income, credit, and financial history. Once the loan is underwritten, it can be approved by the lender taking on the financial risk, and the home purchase finalized.
Your debt to income ratio, or DTI, is a calculation of what percent of your monthly income goes to pay pre-existing monthly debt. A lower DTI can help you qualify for the best home loan.
The loan to value ratio describes what relationship exists between the value of your home and the loan you’ve taken out. If your LTV is higher than 80% (meaning you paid less than 20% down,) you’ll be required to buy private mortgage insurance, or PMI.
PMI and LPMI
Private mortgage insurance (PMI) helps protect your lender in case you default on a home in which you have little equity and is generally a premium that is paid monthly. Lender-paid PMI (LPMI) is paid as either an increased cost at closing or in the form of a higher rate in order to avoid the monthly PMI premiums. If you choose monthly PMI the premium can be removed provided you meet the requirements for PMI removal.
Before you get your home loan, an appraisal must be done by a third party to evaluate the value of the home. This value is used to determine your LTV and equity. Your lender will order the appraisal to ensure it meets Appraiser Independence Requirements. You cannot order your own appraisal and use it as part of a mortgage transaction.
You’ll also need a home inspection to look for any potential problems with the home. It’s not advised to waive inspection, and you should have the inspection done as early as possible in the home buying process in case the results cause your underwriter to put conditions on approval. You’ll need time for repairs to be completed and a re-inspection done before your closing date.
Depending on your lender and type of home loan, you may need to have asset reserves in place to cover future obligations. Typically, for a primary residence, these amount to two months of mortgage payments, homeowners insurance, taxes, and PMI, if applicable.
The down payment may range from 0% to 20% of the entire loan amount. The bigger your down payment, the lower your home mortgage payments will be and the less interest you may pay over the life of your loan. There are many programs that can help you lower your down payment.
Escrows / impounds
An escrow or impound account is set up to hold monies for various purposes during a home sale transaction. Funds held in escrow are designed to provide security for the seller, and cover some of the anticipated costs of the home purchase. Money in escrow may be forfeited to the seller if the buyer backs out for no good reason, or paid towards closing costs. Impounds are funds held by the lender in reserve so that they can make your property tax and homeowners insurance payments when they come due.
The escrow officer is a third party who helps facilitate loan closing. They open, monitor, and disburse funds from escrow accounts, and handle much of the paperwork to ensure signatures are obtained in a timely manner. They also help ensure conditions are met, and all legal steps are followed for a proper transfer of property.
In some cases, the seller may make concessions like a seller credit to help cover closing costs. This is more common at entry level price points that target a lot of first time homebuyers who may not have enough money saved to cover a down payment and closing costs. While a seller concession can cover your closing costs and prepaid items, funds from the seller cannot be used to help with the down payment.
A title company will investigate the property and check for any liens or claims against it. Your lender will require you to purchase title insurance to protect against potential future claims. You can also purchase title insurance to protect yourself as the owner. Depending on the state you are buying your home in, an owner’s title policy may be paid for by the seller.
When you sign the final paperwork to finalize your home purchase, there will be costs due. These costs typically include any taxes owed, insurance premium pre-payments, appraisal fees, and lender origination fees. Escrowed funds may be applied to cover some or all of these costs.
Your lender may offer discount points, which allow you to buy down to a lower interest rate. Discount points are paid for at closing, and are paid based on a percentage of your loan amount. Generally a 1 point buy down will get you a .25% better rate; however, the cost to buy down the rate is not fixed and constantly changes. Your Loan Officer should help walk you through your options and advise you on whether paying points makes sense based on your financial situation and how long you plan on staying in the home.
Amortization details your loan payments from your purchase date to the final payoff. The amortization schedule assumes you make the minimum payment for the entire life of the loan. If you choose to make additional principal payments this will shorten your loan term and reduce the interest paid over the life of your loan.
The principal is the amount of your loan before any interest. Every month, you’ll pay the interest owed on your loan plus a smaller amount towards the principal. As years go by, the interest amount decreases and the principal amount increases until your loan is paid in full.
Your mortgage term is the number of years it will take to pay off your loan with interest. You can shorten or lengthen your mortgage term by paying more money towards principal. Shorter terms will have a higher monthly payment, but you’ll pay off your home faster and pay less interest overall. A longer term means a lower payment, but more years on the note, and more interest paid by the end of the term. Shorter terms often come with lower interest rates as well.
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