Here’s a glossary of mortgage terms and related phrases to help you decipher the process.
List of Common Mortgage Terms and Definitions
An adjustable-rate mortgage is one of the two most common mortgage types. Its interest rate changes after a predetermined fixed period (such as one year, three years and so on). It’s known as an ARM for short.
Allocates how your payments are divided between principal and interest as part of a schedule. For example, a typical amortization schedule for a 15-year loan includes the amount borrowed (principal), interest rate paid and term. The result is a monthly breakdown of how much interest you pay and how much is paid on the amount borrowed. This will come in handy when you itemize your taxes.
Annual Percentage Rate (APR)
The rate of interest paid to the mortgage lender. The rate can either be fixed or adjustable.
An appraisal is conducted by a professional appraiser who inspects the property and gives an estimated value based on condition and comparison with houses sold recently. Appraisals are required by lenders to ensure the house is worth the investment.
Closing costs include attorney fees, recording fees, and other costs you, the buyer, must pay. Closing costs are usually 2 to 5% of the property’s cost, so they can be fairly steep. There are several options to reduce closing costs: You can ask the seller to pay them or you can compare them to standard costs to ensure they’re as low as they should be. Beware of fraudulent or inflated closing costs.
Used when you’re building your own home. With a construction mortgage, the lender advances money based on the builder’s construction schedule. When the home is finished, the mortgage converts to a permanent mortgage.
This is one of the factors that can affect your mortgage eligibility and refers to a numerical score designed to measure your ability to repay a loan. Your credit score takes into account factors such as payment history, length of credit history, credit mix and more.
Your monthly debt divided by your income. Lenders use this to help determine your loan eligibility. The lower your debt-to-income ratio is the better because it shows you can handle your debt and will be able to continue managing it even with the addition of the new loan.
The amount of the purchase price the buyer pays. Most lenders require a 20% down payment, although there are other low down-payment options.
Earnest money is a deposit you usually give to your realtor to show you’re serious about buying. If you buy the home, the funds go toward your down payment. However, if the deal falls through, you may not be able to reclaim your deposit. Earnest money is usually 1 to 3% of the home’s value.
The difference between the value of the home and the mortgage loan. As you pay on your mortgage, your home equity increases.
Escrow can mean two different accounts. One escrow account is where certain funds, such as earnest money, are held until the closing. After you close on your mortgage, you may also have an ongoing escrow account with the mortgage lender for homeowner’s insurance and property taxes, which are collected as part of your monthly mortgage payments and forwarded to your insurer or taxing authority.
Compared to an adjustable-rate mortgage, a fixed-rate mortgage has an interest rate that will not change over the course of your repayment plan. This means your monthly payment will also remain the same.
Good Faith Estimate
An estimate by the lender of the mortgage closing costs. It is not an exact amount, but it gives buyers an idea of how much money they need for closing.
This refers to a formula you can use to determine what a manageable mortgage amount would be based on your income. Mint.com suggests using this income-to-mortgage formula: (Target mortgage payment + consumer debts) ÷ .36 = Gross monthly income needed to qualify. However, you’ll still want to run the numbers with your budget to be sure you can afford a mortgage.
This is the rate that is charged on borrowed money. It is a percentage of the principal loan amount and varies by loan type.
Loan amount versus the value/purchase price of the property). The loan-to-value ratio affects loan eligibility. Lenders usually require your LTV ratio to be 80% or lower to qualify for a mortgage.
Maximum Loan Amount
This refers to the maximum amount that you are qualified for as a borrower. Keep in mind, the amount you qualify for at the bank doesn’t necessarily take into account your other budget items like a cell phone bill, utilities, student loans, etc. In other words, just because you qualify for that maximum amount does not mean that you must take out a loan of that size. Rather, it means you can take out a loan up to that amount.
A mortgage is a binding, legal agreement between a lending institution (typically a bank) and a borrower in which money is lent for a property. The loan is secured by the property and the borrower makes payments per agreed-upon terms until the lender is paid in full.
A mortgage application is a document you fill out and submit to your bank, which they will then review to determine whether you qualify for a mortgage.
A financial institution that lends money for the purchase of real estate.
An origination fee may include an application fee, appraisal fee, fees for all the follow-up work and other costs associated with the loan and is paid to the lender. This is usually expressed in points. These fees are represented as a lump sum on the Good Faith Estimate, so ask for a breakdown to see what you’re actually being charged. These fees are also negotiable, so make sure you’re not paying more than you should.
Percentage points of the loan amount equal to 1% of the total loan. For example, $1,000 is 1 point for a $100,000 loan. To get a lower interest rate, lenders may allow borrowers to “buy down” the rate by paying points. Paying a percentage point up front in order to get a lower rate will save you money if you stay in the house for the duration of the loan. If you move shortly after buying the property, you’ll probably lose money.
PITI is an acronym that stands for principal, interest, property tax and insurance.
Getting pre-qualified for a loan happens after a lender has reviewed your credit and financials and has given you an amount that they are willing to let you borrow. This gives you an idea of what price range you should be looking for and can help when you decide to offer on a home.
At Mercer Savings Bank, for example, when you prequalify for a loan we’ll send you pre-qualification letter that you can use to assure real estate brokers and sellers that you are a qualified buyer. Having a pre-qualification for a mortgage may give more weight to any offer to purchase that you make.
Private Mortgage Insurance (PMI)
A monthly premium for those borrowers whose loan-to-value (LTV) ratio is higher than 80%. PMI covers the lender in case of default until the borrower reaches an 80% LTV ratio. Instead, many people who require PMI take out a second mortgage to use as a down payment on the first.
The size of your loan is what is referred to as the principal—so, for example, if you took out a $100,000 mortgage, your principal amount to begin with would be $100,000. As you make payments, your principal will decrease. However, keep in mind that when you make payments on your loan, you’re paying down the principal and paying on the interest that has been accrued.
Lenders will often look at your savings history when determining your loan eligibility. If your recent bank statements reveal an increase in your savings, that shows that you were able to save money even with your current debt.
Include closing costs, prepaid interest, tax and insurance escrow and the down payment.
Ensures the property’s title is clear of any liens. A lien is basically the legal right to keep possession of property belonging to another person until a debt owed by that person is discharged and is always recorded by the government. A lien would jeopardize the mortgage, because the lender is using the home as collateral for the mortgage transaction. If someone else has a right to part of that, the lender could lose money.
Truth in Lending
Truth in Lending regulations including proper disclosure of rates, how to advertise mortgage loans and many other aspects of the lending process. These regulations were put in place to protect consumers.
Underwriting refers to the process a lender goes through to determine whether an applicant should receive a loan or whether they’re too much of a risk. The lender looks at many different factors during this period to make the determination, including your credit, capacity (ability to repay the loan) and collateral.
Looking for Mortgage Guidance?
Securing a mortgage can be a confusing process. If you have questions about mortgages or would like to discuss your options for a home loan, contact a Mercer Savings Bank representative and they’ll be able to help.