If you’re a first-time homebuyer, then you may find that the language used in the mortgage world can be intimidating, making the process seem more complicated than it is.
Here’s a crash course in mortgage terminology and a rundown of key mortgage loan terms to help you navigate the process of shopping for a home loan and choosing the right mortgage for you.
With an adjustable-rate mortgage, your interest rate will go up or down at certain intervals, changing your monthly payment along with it.
Amortization is the process of paying down the principal and interest on a home loan in regular payments over the loan’s repayment period.
Annual Percentage Rate
APR represents the annual cost of a loan as a percentage rate. It includes the interest rate, lender fees, mortgage points, and any other charges you have to pay.
Closing costs refer to the fees that the buyer must pay to take out a loan and transfer ownership of a property.
A conforming loan is a conventional mortgage that meets the requirements — primarily a maximum loan amount — for the lender to sell it to Fannie Mae or Freddie Mac, which are government-sponsored enterprises.
Contingencies refer to any conditions the buyer and seller agree must be met for the sale to close.
The most common type of mortgage, conventional loans are issued by private lenders without government backing. There are two types of conventional loans: conforming and nonconforming.
Your credit score is a three-digit number that credit bureaus calculate to represent your credit history. It tells lenders how well you’ve handled credit in the past, which guides their estimation of how likely you are to repay future loans.
Your debt-to-income ratio is a percentage that shows how much of your income is needed to pay your debts each month.
Discount points are a way buyers can pay interest on a home loan upfront, lowering the interest rate that will be applied to the monthly mortgage payment.
Your down payment is the amount that you pay toward the home upfront, like a deposit, and is calculated as a percentage of the total purchase price.
Buyers often pay the seller earnest money — also known as a good faith deposit — when the sales agreement is signed to show they are serious about buying the home.
Escrow is an account managed by a third party to hold funds and ensure proper payment in a transaction. Escrow accounts are used in two ways:
- To hold the buyer’s earnest money in a real estate transaction.
- For the lender to collect funds from the borrower to pay their property taxes and homeowners insurance premiums.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are government-sponsored enterprises that buy conforming mortgages from lenders and banks. This reduces the lenders’ risk and frees up cash for them to make more loans.
The interest rate on a fixed-rate mortgage is set when the loan is approved and remains unchanged over the entire term of the loan.
Government-backed loans are offered by private lenders but insured by the federal government. The Federal Housing Administration, Veterans Affairs, and Department of Agriculture insure the most common government-backed loans.
The home appraisal is an estimate of a property’s fair market value from an independent third-party professional.
The home inspection is a thorough examination of a home’s condition to confirm that it’s safe and its systems function correctly, and to document any flaws, damage, or defects prior to closing.
Homeowners insurance reimburses homeowners for damage to the structure of their home, loss of personal belongings, and liability claims.
The interest rate represents how much you pay each year to borrow the principal you use to buy a home, and is expressed as a percentage rate.
Your loan estimate is a standardized three-page document that lenders are required by law to provide within three business days of receiving a mortgage application. The loan estimate contains details of the loan you qualify for.
The loan term refers to the length of time over which the loan is scheduled to be repaid. The most common loan terms are 30 years or 15 years, but custom terms also are available.
Your loan-to-value ratio shows how much of your home’s value you are borrowing.
Nonconforming loans are conventional loans that don’t meet the requirements to be sold to Fannie Mae and Freddie Mac, usually because the loan amount exceeds the conforming loan limit. Such loans also are called jumbo loans.
Preapproval usually takes the form of a letter from a lender that has done a cursory review of your finances. It details how much of a loan the lender expects you to qualify for. Preapproval isn’t a guarantee that your loan will be approved.
Like preapproval, pre-qualification is a letter from a lender estimating how much of a loan you’re expected to qualify for. Pre-qualification is usually based on self-reported financial information instead of lender-reviewed documents.
The principal is the amount of money you’re borrowing to buy a home with.
Private Mortgage Insurance
PMI is a policy that protects your lender in the event that you default on your mortgage. PMI typically is required as long as your equity in the home is less than 20%.
Property taxes are local taxes that are charged based on the value of your property.
A purchase agreement is a legally binding contract signed by the buyer and the seller that outlines the terms and conditions of the home sale.
When you refinance, you pay off your current mortgage with money from a new mortgage that has more-favorable terms.
A reverse mortgage allows older homeowners to borrow their equity as cash while they continue to live in the home. Instead of making monthly mortgage payments, the homeowner receives cash and their equity in the home decreases. The loan is due when the borrower no longer lives in the home, and usually is repaid by selling the home.
A property title search digs into public records to confirm that the seller is the legal owner of the home, and that there are no liens or outside claims on the property.