Especially for first time homebuyers, there’s plenty of unfamiliar lingo floating around throughout the process – especially when it comes to mortgage terms. If you’re feeling a little unsure about what it all means, there’s no need to be intimidated! Here are 13 key mortgage terms to get familiar with so you’ll feel in-the-know as you walk through the process.
1. Adjustable-Rate Mortgage (ARM)
This is a type of mortgage loan that has an initial interest rate that is fixed for a period of 5-10 years, but then adjusts annually (or even monthly) to fall in line with current interest rates. Although ARMs make some homebuyers nervous, some adjustable-rate mortgages have limits on how high your rate can increase. (This is in contrast to a fixed-rate mortgage, one of the mortgage terms we’ll discuss below.)
2. Closing Costs
These are expenses that you pay in addition to the price of your new home – usually 2-5% of the purchase price. Closing costs include things like appraisal fees, title fees, loan origination fees, credit report costs, etc. You’ll pay all costs associated with your mortgage at the closing (the day you’ll sign all the paperwork and receive the keys to your new home). Within three days of receiving your loan application, the lender will provide you with a three-page loan estimate detailing the fees you’ll be responsible for.
3. Debt-to-Income Ratio (DTI)
DTI is one way lenders determine your ability to afford your mortgage payment while paying your other months debts. It’s calculated by adding up all your monthly expenses then dividing it by your income. Although a DTI under 36% is the gold standard, some lenders may approve a DTI as high as 50%.
4. Down Payment & Gift Funds
Money paid on the purchase of the house from the buyer’s own funds is known as the down payment. With most loans gifts may also be used, but the buyer must provide clear documentation showing how they received the gift and from whom. A 60-day “seasoning period” is ideal for deposits that will be used as part of a down payment. In other words, sudden large deposits that are quickly turned around and used for a down payment can raise eyebrows, so plan ahead.
5. Fixed-Rate Mortgage
When you lock in your interest rate with your lender on this type of mortgage, the rate remains fixed. This means your monthly payments stay the same for the duration of the mortgage. (This is in contrast to an adjustable-rate mortgage, one of the mortgage terms we discussed above.)
6. Good Faith Estimate (GFE)
Within 3 days of submitting your application you should expect to receive this all-important document estimating the costs that come with your mortgage. These include the interest rate, lender’s fees, title charges, and — if they apply — prepaid interest and homeowner’s insurance.
When you pay back the money you borrowed from your lender, the additional you’ll money you’ll owe is called interest, one of the key mortgage terms you’ll want to be familiar with. It’s a percentage of the principal you borrowed. Loan-to-value ratio. This is the amount of the mortgage lien divided by the property’s appraised value. (So if you’re taking on a $92,500 mortgage to purchase a home appraised at $100,000 you’d have an LTV ratio of 92.50%) Keep in mind that if your LTV ratio is greater than 80%, you’ll most likely need mortgage insurance.
8. Loan-to-Value Ratio
This is the amount of the mortgage lien divided by the property’s appraised value. (So if you’re taking on a $92,500 mortgage to purchase a home appraised at $100,000 you’d have an LTV ratio of 92.50%) Keep in mind that if your LTV ratio is greater than 80%, you’ll most likely need mortgage insurance.
9. Points or Discount Fees
Points or discount fees can be part of your overall closing costs. Points or discount fees are quoted to help lower the rate which helps the borrower qualify for a higher purchase price. They’re calculated as a percentage of the principal and charged by your lender. One point equals 1% of your loan, or $5,000 on a $500,000 mortgage.
After you’ve made your down payment, the remaining money you owe on your home is known as the principal. Each month part of your mortgage payment goes towards principal and part of it goes to pay the interest.
11. Private Mortgage Insurance (PMI)
PMI is required by lenders when you put less than 20% down on your home. This protects the lender from borrowers who default on a loan. The most common way to pay for PMI is through a monthly premium that’s added to you mortgage payment.
12. Rate Lock
Once you’ve secured an interest rate you’re comfortable with, you’ll want to keep it in effect from the time you submit your loan application until closing by locking it in with the bank. This rate lock only applies if you close by the agreed-upon deadline (60 days is typical). Otherwise, lenders will keep reacting to changes in the financial markets by changing interest rates – and that means yours will change, too.
13. Title Insurance
One of the closing costs you’ll incur is title insurance. A title insurance policy protects you and the lender against losses that happen because of property ownership disputes. This can sometimes include title fraud or forgeries, but can also happen when other liens or owners haven’t been named as sellers. Titles searches are conducted by reviewing public records to make sure the property is eligible for sale.
Mortgage Terms To Remember
Keep this list handy and refer to it as you go through the homebuying process. There’s a lot to remember, but you’ll learn quickly as you embark on this new adventure. There certainly will be times when you feel a little lost, but take comfort in the fact you’ll be surrounded by knowledgeable people who can answer your questions or point you in the right direction to learn more.
In the meantime, brush up on these mortgage terms and enjoy the ride!