Does it seem like people in the mortgage industry are speaking another language? That’s because they are.
The process of buying a home and applying for a mortgage loan can be challenging if you’re not familiar with some of the common words, terminology, and language of real estate. However, being prepared for this and having a basic understanding of terms you may come across can allow you to move more quickly and be a more competitive buyer.
It’s currently a seller’s market when it comes to real estate. Not only are sellers all across the country getting multiple offers in a short period of time, but many houses are also being sold above the initial asking price. It’s not unusual to hear stories from home buyers having multiple offers rejected given the current competitive market for housing.
Buyers can improve their chances of getting an offer accepted on their dream home by having their ducks in a row. Having a good understanding of the terminology involved will allow you to more quickly and decisively.
Here is a list of some common terms you may come across in your journey to becoming a homeowner.
Table of Contents
Mortgage Glossary of Terms
Adjustable Rate Mortgage (ARM)
An adjustable-rate mortgage (ARM) is one in which the interest rate and corresponding payment amounts are subject to change after a specified period of time. In exchange for the possibility of the rate changing, ARMs typically offer a more competitive up-front rate when compared to a fixed-rate mortgage. Borrowers should be careful to consider whether they can afford the possibility of increased payment amounts if they do not refinance or sell the home.
Amortization is the process by which payments on your loan are calculated such that it will result in the loan being paid off after a specified period of time. For example, on a conventional 30-year fixed-rate mortgage, monthly payments will be calculated such that each of the 360 months’ worth of payments will result in the loan being paid off in 30 years.
Annual Percentage Rate (APR)
The APR on a mortgage loan is a figure that lenders are required by law to disclose to borrowers. It is a figure designed to represent the total cost of borrowing and includes certain fees for the loan. In other words, the APR is essentially the interest rate plus fees charged by the lender.
In obtaining a mortgage loan, most lenders will require an appraisal to determine the value and condition of the home. The appraisal fee is the cost to have an appraiser inspect the property and to complete a report supporting their analysis of what the property is worth. The appraisal report contains information about the characteristics of the home, neighborhood, and comparable sales in the area.
A credit score is a three-digit number that lenders use to determine how likely you are to repay a loan. Lenders will also utilize your credit score to determine whether you qualify for a loan and how much to charge you. Lenders will typically pull your scores from three of the major credit bureaus, Experian, Transunion, and Equifax.
The debt ratio is one of the figures lenders look at to determine how large of a loan they will extend. Debt ratio is calculated as the amount of your total monthly payments, divided by your gross monthly income. Monthly payments can include things like credit cards, car payments, student loans, mortgages, federal tax payments, and alimony/child support payments. The maximum debt ratio allowed is often determined by the type of mortgage loan you apply for.
The down payment on a home is what home buyers pay as a one-time upfront payment, and is a percentage of the cost of the home. Certain loan programs may require a minimum down payment as a condition of granting a buyer a loan. While some programs require no down payment, most conventional loans require anywhere from a 3% to 5% down payment at a minimum.
The amount of the home you own is called equity and can be determined by taking your home’s value and subtracting the balance of any mortgages or home equity loans on the property. Homeowners who have built up sufficient equity in their home can use it to get cash in their bank account with a cash-out refinance or home equity loan.
As a neutral third party to the transaction, escrow temporarily holds funds in the purchase and sale of a home. Escrow follows the mutually agreed-upon instructions of both the buyer and seller with regards to how deposits should be handled and is designed for the safety of both parties as it ensures adherence to the terms of the purchase. Escrow can also be used to refer to an account lenders use to hold funds to pay for your property taxes and homeowner’s insurance, and is something that may be required by the lenders or the borrowers.
FHA loans are insured by the Federal Housing Administration are less strict on credit and down payment requirements. FHA loan rates are not as competitive as conventional loans. But borrowers who can’t qualify for conventional loans due to credit blemishes may be able to qualify for an FHA loan.
Fannie Mae is a government-sponsored entity under the supervision of the Federal Housing Finance Agency (FHFA). Fannie Mae purchases mortgage existing loans that satisfy its criteria. Many mortgage lenders have Fannie Mae as a buyer/investor, and as a result, will review its loans in accordance with Fannie Mae guidelines. These requirements can include things such as minimum down payment amounts, credit requirements, income documentation requirements, and more.
First-Time Home Buyers (FTHB) Loan Programs
Depending on the location, some cities, counties, and states offer financial assistance for first-time home buyers. First-time homebuyer programs can offer down-payment assistance, loans, and grants. These programs often require buyers to meet certain eligibility requirements but can be a huge help in helping more individuals land their dream homes.
With a fixed-rate mortgage, borrowers can be assured that the interest rate will never fluctuate for the entire length of the loan. Outside of the possibility of your property taxes and homeowner’s insurance changing annually, the principal and interest portions of the loan are guaranteed to remain the same, and will never increase or decrease unless the loan is paid off or refinanced.
Foreclosure describes the process of a lender taking possession of a home, often as a result of the homeowners having missed multiple consecutive mortgage payments. Depending on where the property is located, borrowers must miss a certain number of payments before a lender may begin foreclosure proceedings. If a borrower finds themselves in a missed mortgage payment situation, it can be helpful to speak with the lender to see what your options are to avoid a foreclosure.
Freddie Mac is another government-sponsored entity responsible for purchasing and backing mortgage loans from lenders. Just like Fannie Mae, lenders who sell to Freddie Mac must ensure that the loans meet their criteria. Once purchased by Freddie Mac, the loans are then sold to private investors, which in turn increases the amount of money supply for the real estate market.
Prior to granting a borrower a home loan, many lenders will require a home appraisal to be completed so that the value and condition of the home can be reviewed to determine if it meets the lender’s requirements. This appraisal typically involves having a certified appraiser inspect the home and research surrounding areas to determine the market value of the house.
The interest rate on a loan reflects how much it costs to borrow money from a lender. The interest rate on a loan is one of the factors that determine your monthly payment amounts. Borrowers with strong credit scores and larger down payments can usually qualify for more competitive interest rates and lower monthly payments.
Your loan-to-value ratio (LTV) is calculated as the amount of your loan divided by the value of the property. The LTV is a figure that lenders will most likely look at to determine how much they can lend to you. A lower LTV means a lower risk to the lender and often results in fewer fees being charged. Loans with a higher LTV, on the other hand, will typically involve more fees as a result of the higher level of risk to the lender.
Usually seen on adjustable-rate mortgages, the margin on a loan is an additional amount of interest that lenders may charge on top of an ARM’s index value. Together, the index value and margin are two items that determine the interest rate on your loan. The higher the margin, the more you can expect to pay.
In determining how much to lend, lenders will take into consideration your monthly expenses to ensure you can afford the monthly payments on the loan. Monthly expenses can include payments on credit cards, student loans, mortgages, car loans, IRS installment payments, or court-ordered obligations such as alimony and child support.
A mortgage is a loan that uses your home as collateral in the event payments are not made in a timely manner. In other words, if a borrower is unable or unwilling to make payments on a mortgage loan, it could result in the lender eventually taking possession of the property.
Mortgage insurance is an added cost to the loan that is typically charged to borrowers who are purchasing a home with less than 20% as a downpayment. Mortgage insurance can be added to the monthly mortgage payments or as a one-time upfront payment to the loan. Mortgage insurance (MI) or private mortgage insurance (PMI) protects the lender in the event a borrower stops making mortgage payments. As a borrower, it could be worthwhile to save up for a larger down payment to avoid this added cost.
A mortgage refinance occurs when the balance of your existing mortgage is paid off and is replaced with another mortgage loan. This process can be in the form of a rate-and-term refinance, changing your monthly payments by switching to a different loan term, interest rate, or loan amount. If you have enough equity in your home, you could also get cash deposited to your bank account with a cash-out refinance to pay for things like educational expenses, home improvements, or pay off other debt.
The length of your mortgage is one factor that will determine your monthly payment amounts. Some popular mortgage terms include 10, 15, 20, 25, and 30-year terms.
Principal refers to the balance on your mortgage loan that you owe and does not take into account any interest charges. Mortgage payments typically have a portion that reduces the principal balance on the loan, while the rest is applied only towards the accrued interest.
With few exceptions, virtually all homeowners must pay a tax on the properties they own each year. Taxes are collected by the city or county in which the property is located and are usually determined by their assessment of the value of your property. The funds collected from property taxes are typically used to fund public services such as maintaining our roads and school systems.
A reverse mortgage allows homeowners, typically age 62 and older, to take the equity in their home and exchange it for regular monthly payments as income. In other words, instead of a borrower making payment to a lender, a reverse mortgage results in a scenario where a lender makes payments to the homeowner.
A second mortgage is a loan made against a property that already has an existing mortgage loan. Second mortgages can be in the form of a home equity loan or a home equity line of credit. Existing homeowners can take out a second mortgage on their home if they need additional cash in the bank for things like home improvements or to pay for other expenses.
Subprime mortgages are typically geared towards borrowers who have a high debt-to-income ratio (DTI) or lower credit scores as a result of negative items on their credit, such as bankruptcies, collections, or other late payments. Since lenders view these types of borrowers as higher risk, subprime mortgages generally have higher interest rates and fees.