11 Mortgage Terms You Should Know
"I put 20 down to avoid PMI and started with an ARM but after the fixed term ended, I decided a 30-year was better suited for me, so refi'd."
What?? When did everyone get so savvy about mortgages? With its specialized terminology and variety of acronyms, it can be difficult to start your home loan journey, especially if you're a first-time buyer.
This mortgage lingo cheat sheet will give you some quick insights on the terms you're most likely to encounter so you can negotiate like a pro.
Get Free QuotesPrivate Mortgage Insurance (PMI)
Private mortgage insurance is a type of insurance that a lender may require a borrower to obtain. PMI is typically found in conventional loans when the borrower makes a down payment that is less than 20 percent of the house's purchase price.
As this is just one more payment to worry about, most borrowers work hard to avoid PMI, so start putting money aside for a down payment now! If you do end up having to obtain PMI, it's not a bill you'll be dealing with forever. As soon as you have 20 percent equity in your home, you can request that the lender cancel your PMI requirement.
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Equity
Home equity is the value of your ownership and is found by subtracting the total amount you owe from the home's appraised value. You first acquire equity in your home with your down payment. So if you purchase a home for $400,000 and put 20 percent down, or $80,000, your initial home equity is $80,000.
As years go on and you make payments, you build equity. Unfortunately, equity is not always under your control. Equity can decrease if your house were to lose value, as sometimes happens during a recession. Conversely, your home equity can rise, should the value of your home increase.
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Annual Percentage Rate (APR)
This is different from an interest rate. The annual percentage rate more accurately reflects the true cost of borrowing. It includes things like broker fees, interest rates, and any other charges that the borrower is required to pay. It's important to understand all that is or is not included in an APR. You don't want any surprises when it comes time to pay bills!
Mortgage Interest Rate
The interest rate is the cost of borrowing the principal loan amount and does not include other fees that are associated with getting a mortgage. It is determined by the borrower's credit score and the current market.
Amortization Schedule
Amortization is a way to spread out costs over time, hence, a mortgage amortization schedule is a table that shows regularly scheduled payments and how those payments are being distributed. A table typically shows the beginning balance, interest, principal amount, and ending balance.
Adjustable-Rate Mortgage (ARM)
This is a type of mortgage in which the interest rate on the outstanding balance varies throughout the life of the loan. An ARM starts with a fixed rate for a certain amount of time. After that time, the interest rate resets. It's important to note that there are limits on how much the rate or payment can rise, which does add a measure of protection for the borrower.
An ARM is a popular choice for buyers who are not looking to stay in their home for an extended period—typically, less than seven years.
Fixed-Rate Mortgage
A fixed-rate mortgage is one that has a set rate of interest. Many people prefer to have set, predictable payments so that there are no surprises over the life of the loan. It's important to note that payments on this type of mortgage tend to be higher than an ARM, at least for the initial term.
Down Payment
You've probably run into this term before. Down payment is included on this list of need-to-know mortgage terms because what most people don't realize is that it is only a partial payment for the purchase of the house and does not include closing costs. Many buyers, especially first-time homeowners, are surprised to find that they owe an additional amount of money and some aren't financially prepared for these extra costs.
Closing Costs
Separate from a down payment, closing costs are all the costs that are associated with applying for, processing, and closing a mortgage loan. They include things like home appraisals and underwriting fees and are typically between two to five percent of the sale price. Keep in mind that the costs that go to the lender, like underwriting and processing, can be negotiated. Don't hesitate to chat about the bottom line when it comes to lender charges, you might get a better offer than what was initially presented!
Underwriting
At its core, underwriting is the process that a lender uses to determine if a borrower qualifies for a mortgage. The lender is essentially assessing the risk that comes with lending a significant amount of money, and how likely they'll get their money back during the outlined terms. Assets, debt, income, and property details are all verified at this point. The process typically takes more than a week to complete, although it can be completed in a few days under certain circumstances.
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Refinancing
Refinancing is the process of replacing an existing mortgage with a new one. Why do people refinance? Typically to reduce their interest rate, take cash out, or lower monthly payments. For this reason, it's important to pay attention to the market and make use of competitive terms as they become available. What many don't realize is that it can be expensive to refinance, at least upfront, because there are closing costs. Don't forget to do your research to ensure that your new terms far outweigh any closing costs you'll be responsible for.
Conclusion
Don't be thrown off by home loan jargon. Simply review these common terms used in mortgage lending before exploring your loan options and looking at quotes. While specifics are always changing within the mortgage realm, having a good understanding of common terms used provides a great foundation on which to build upon!
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