The home buying process is complicated. When you buy a home, there are a lot of boxes to check off and variables to take into account. This is particularly true if you’re buying a home with a mortgage loan. The mortgage loan acquisition process adds a whole extra layer of complexity on top of the home purchase. There is a great deal of preparation which goes into the mortgage application process. You need to make sure that your financial situation is suited to applying for the mortgage loan. You need to gather copious documentation in order to substantiate your financial situation. You need to build a credit score which is sufficient to obtain a good interest rate. In short, obtaining a mortgage loan isn’t a small task, and it’s something to which you’ll need to dedicate considerable time.
To aid buyers in the mortgage loan process, we’ve put together this short list of words you should take the time to learn. These are mortgage words first home buyers need to know. Learning these common mortgage terms will undoubtedly assist you as you go to apply for a mortgage loan. Learning new mortgage terms is one of the more challenging aspects of applying for a loan. When you apply, you’re likely to encounter all sorts of foreign phrases which can cause confusion and even intimidation. The good news is there’s no reason to be worried.
As long as you put in the time, you’ll be able to educate yourself and find the mortgage loan which is perfect for you.
Before applying for a mortgage, it helps to understand the basic terms you’ll encounter throughout the home financing process. These concepts affect your loan structure, monthly payment, and long-term borrowing costs.
In accounting, the term “amortization” refers to the deductions taken over the course of the useful life of an intangible asset. But in lending, amortization refers to a set schedule for the repayment of a loan. A standard amortization schedule will include the amount borrowed, the interest paid on the loan and the time period for repayment. An amortization schedule will therefore spell out exactly how much interest you pay on each payment and exactly how much you’ve paid after a given number of payments. This is a word you’re very likely to encounter when you go through the mortgage loan application process and so it’s key that you understand the definition.
The principal is the amount of money you borrow on your mortgage loan. It is separate from the interest charged by the lender. As you make mortgage payments, a portion typically goes toward reducing the principal balance over time.
The interest rate you pay to borrow money when buying a home. The lower the rate, the better. Your mortgage rate will depend on a lot of factors, including your credit, your down payment, and whether or not you buy discount points to drop your interest rate. It’s important to know your actual mortgage rate, which is how much the loan costs you in total counting fees in addition to the interest.
Unlike a fixed-rate mortgage, an adjustable rate mortgage (ARM) is one which has an introductory rate which then changes over time. Typically, this means a relatively low introductory rate and then higher rates later on throughout the course of the loan. If you obtain an ARM, you need to take into account these higher future rates and be able to service the higher payments which will follow from them. In many cases, the payment structure can change dramatically as a result of these changed rates. ARMs played a big role in the housing crisis of the late 2000s. Many people took on ARMs which they couldn’t service after the introductory low interest rates changed.
A fixed-rate mortgage is a home loan with an interest rate that stays the same for the life of the loan. This means the principal and interest portion of the monthly payment generally remains consistent over time. Many buyers prefer this type of mortgage because it offers predictability.
Conventional loans are standard mortgages not guaranteed by the Federal Housing Administration (FHA) or VA. Conventional financing generally requires a larger down payment, although there are options with as little as 3% down. They also have lower debt to income ratio requirements along with higher credit score requirements.
APR represents the total annual cost of borrowing money, including the interest rate and certain lender fees. Because APR includes additional costs, it often provides a more complete picture of a loan’s true cost than the interest rate alone. Comparing APRs can help home buyers evaluate different mortgage offers more accurately.
Your down payment and the amount of equity you build in your home play a significant role in mortgage qualification, loan costs, and future financial flexibility.
Down payments are typically 3.5-20% of the purchase price of the home. Some 0% down programs are also available. You can often take advantage of state or local programs for help with your down payment. The more you put down, the lower your principal will be, and the less you will pay in interest over the life of the loan.
Loan-to-Value (LTV) ratio is another term you’re more than likely see at some point when you apply for a mortgage loan. Simply put, loan-to-value ratio refers to the ratio between the mortgage amount and the appraised value of the home. A good way to think about loan-to-value is to think of it as the remainder after the down payment is made on the home, and this remainder is then expressed as a percentage. For instance, if you make a down payment of 25% of the appraised value of a home, then the LTV would be 75%, because the loan would represent 75% of the home’s overall value.
The value in your home above the total amount of liens against your home. With today’s price appreciation, many homeowners are realizing they have more equity than they thought and they’re using it to move.
Private Mortgage Insurance (PMI) is typically required on conventional loans when the down payment is less than 20% of the home’s purchase price. PMI protects the lender if the borrower defaults on the loan. While it increases the monthly payment, PMI can often be removed once sufficient home equity has been established.
Mortgage lenders evaluate several factors when determining whether a borrower qualifies for a home loan. Understanding these terms can help you prepare for the approval process and improve your chances of securing favorable financing.
A number ranging from 300-850 that’s based on an analysis of your credit history. This helps lenders determine the likelihood you’ll repay future debts. The higher your credit score, the better your chances at a lower down payment and a lower mortgage rate.
When you apply for a mortgage loan, lenders will evaluate your eligibility according to numerous criteria. One variable which mortgage lenders will take into account is your debt-to-income (DTI) ratio. Your debt-to-income ratio is simply a measurement of your monthly income and your recurring monthly expenses. This ratio is measured in order to give the lender a sense of how comfortably you can take on additional financial obligations. If your DTI ratio is too high, then the lender may see this as a sign that you may not be able to repay your loan in the event of an unexpected material setback. Here’s an example: if you have a monthly income of $6,000, and recurring monthly debts of $2,500, then your DTI ratio would be 41.6%, because $2,500 divided by $6,000 is approximately 41.6%. Most lenders prefer to see DTI ratios in the low 40 percent range, although a higher DTI ratio may be offset with other factors, such as significant cash reserves.
Prequalification is an early estimate of how much you may be able to borrow for a mortgage. It is generally based on basic financial information you provide to a lender. While it can be a helpful starting point, it is not the same as a full preapproval.
A letter from a lender that shows what they’re willing to lend you for your home loan. This is a critical step in today’s competitive market. A preapproval isn’t the same as a prequalification, which is just an estimate of how much you might be able to borrow. A preapproval includes verified information and may even be underwritten up front.
A measure of whether someone earns enough to qualify for a loan on a typical home based on the most recent price, income, and mortgage rate data. As prices and mortgage rates continue to rise, that will impact how much home you can afford.
Underwriting is the process lenders use to review a borrower’s financial information and assess the risk associated with approving a mortgage. During underwriting, the lender evaluates income, assets, credit history, employment, and the property itself before making a final lending decision.
Several important steps occur between having an offer accepted and receiving the keys to your new home. These terms are commonly encountered during the purchase and closing process.
A report highlighting the estimated value of the property completed by a qualified third party. Lenders rely on appraisals to validate a home’s value and ensure they’re not lending more than the home is worth. Your lender will mandate an appraisal be done to ensure they aren’t lending more than the home is worth.
A provision in a contract requiring an inspection to be completed. While it can be tempting to waive in a competitive market, the home inspection is essential. It gives you information on the home’s condition and potential repairs.
The phrase “closing costs” refers to the standard costs which are incurred as a result of closing a real estate transaction. There is a wide variety of possible closing costs. The exact costs will always depend on the specifics of a given transaction. Some closing costs may be paid by the seller, and some may be paid by the buyer. Typical closing costs include things like appraiser’s fees, escrow fees, recording costs, transfer taxes, insurance fees, real estate agent commissions, and so forth. Closing costs need to be borne in mind whenever you plan to buy a home because they can add up to constitute a significant chunk of your overall cost burden.
Escrow refers to a neutral third-party account used to hold funds and documents during a real estate transaction. After closing, some lenders also maintain escrow accounts to collect and pay property taxes and homeowners insurance on the borrower’s behalf.
Related: What are closing costs and how do I avoid paying them?
Again, these are just a few of the more common mortgage terms you’re likely to encounter as you enter the mortgage loan application process. You’re likely to encounter many others as well. Hopefully, having these mortgage terms explained will assist you as you begin to explore your options.
Will you need mortgage financing to buy a home? Sammamish Mortgage can help. We serve clients across Washington, Idaho, Colorado, Oregon, and California. Since 1992, we’ve been providing several mortgage programs and products with flexible qualification criteria to borrowers across the Pacific Northwest. Visit our website to get an instant rate quote or to use our online mortgage calculator. Or, reach out to us if you are ready to get pre-approved for a mortgage.
Amortization is the repayment schedule for a loan showing how each payment is split between principal and interest over the loan term.
Loan-to-value ratio compares the mortgage amount to the appraised value or purchase price of the home. A lower LTV usually means less lender risk.
Closing costs are the fees and expenses paid to complete a real estate transaction, such as appraisal fees, escrow fees, recording charges, taxes, insurance fees, and commissions.
Debt-to-income ratio measures monthly recurring debts against gross monthly income. Lenders use it to evaluate whether a borrower can comfortably handle a mortgage payment.
A conventional loan is a mortgage that is not backed by the FHA or VA. It often has stricter credit and qualification requirements than some government-backed loans.
An adjustable-rate mortgage, or ARM, has an initial interest rate that can change over time based on the loan terms and market conditions.
A down payment is the portion of the home’s purchase price paid upfront by the buyer. A larger down payment generally reduces the loan amount and total interest paid over time.
A credit score helps lenders assess the risk of lending money. Higher credit scores can improve the chances of approval and may help borrowers qualify for better mortgage rates.
A pre-approval letter is a lender’s written estimate of how much a borrower may qualify to borrow based on reviewed financial information. It can strengthen an offer in a competitive market.
Home equity is the difference between the home’s current value and the total amount owed on mortgages or other liens secured by the property.
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