MORTGAGE GLOSSARY
Mortgage terms that every homeowner should know!
Adjustable rate mortgage (ARM)
A mortgage with an interest rate that adjusts periodically, after it has stayed at the same rate for a certain amount of time. An ARM usually starts with an interest rate that’s lower than that of a fixed-rate mortgage, but it changes over time based on the index and margin. To some borrowers, this option may seem risky, and many borrowers prefer a fixed rate because they get to enjoy consistent monthly payments (which can help simplify budgeting). But for other borrowers, an adjustable rate means a possibly lower rate, which can result in lower monthly payments during those favorable market times.
Amortization
The process of paying off a mortgage in planned, incremental payments. For mortgages, this is often displayed in a table, called an amortization schedule, and shows the estimated monthly payment, the interest portion of the payment, the principal, the remaining balance, and more. Amortization helps the borrower estimate how much they’ll pay over the course of their loan and helps give a clear picture of how much they’re paying at any given time.
Annual percentage rate (APR)
The total yearly cost of a mortgage expressed as a percentage. Not to be confused with interest rate. APR gives the borrower a bigger picture of what it costs to finance their loan by accounting for the interest rate and finance charges. This is also why the APR is likely to be higher than the rate stated on the mortgage. By comparing APRs from different lenders, home buyers can get an idea of the true cost to borrow. And, it prevents lenders from advertising a low rate while hiding fees.
Appraisal
A part of the mortgage process that helps determine the value of a home. During an appraisal, a professional appraiser walks through the home looking for issues that may affect the value of the home. They also research the recently sold comparable homes (or comps) in the area to help determine the value. The appraiser is legally required to be an unbiased third party. The result of the appraisal is a final report from the appraiser on the current fair market value of the home.
Closing costs
Costs that the home buyer is required to pay before their loan closes. Closing costs can be anything from attorney fees and recording fees to miscellaneous costs associated with the mortgage closing.
Closing disclosure
A Closing Disclosure is a document that provides final details about your home loan. It includes things like the loan terms, your projected monthly payments, and a breakdown of how much you’ll pay in closing costs. Your lender is required to give you a Closing Disclosure at least three business days before you close. This window allows you to review the numbers and gives you a chance to ask questions before you reach the closing table.
Construction mortgage
When a home buyer is having their home built on a piece of land, they will usually finance the purchase and construction of the home with a construction mortgage. The lender will advance money based on the builder’s construction schedule. After the home is done being built, the construction mortgage will convert to a permanent mortgage.
Debt-to-income (DTI) ratio
The relationship between a home buyer’s total monthly debt payments (including proposed housing expenses) and their gross monthly income. This calculation is used in determining the mortgage loan amount a borrower qualifies for.
Down payment
The amount of the home’s purchase price that the home buyer is agreeing to pay up front. Generally, mortgage lenders require a specific down payment in order to qualify for the mortgage, and that amount depends on the loan product or program.
Equity
The difference between the value of the home and the remaining mortgage balance is called equity. In other words, it’s the portion of the home that the homeowner truly “owns.” Over time, as the value of the home increases and the amount of the loan decreases, the equity of the home generally increases, depending on market conditions.
Escrow
In mortgages, escrow is an account that the mortgage lender establishes on behalf of the borrower which holds the money they pay toward property taxes, homeowners insurance, and mortgage insurance, if applicable. Then, when it comes time to pay those bills, the money in the borrower’s escrow account will be automatically distributed. With an escrow account, homeowners don’t have to worry about getting property tax and homeowners insurance bills in the mail. That money is already included in their monthly mortgage payment so, when the time comes, their loan servicer will distribute the funds appropriately.
Fixed-rate mortgage
A mortgage where the interest rate and the term of the loan are negotiated and set for the life of the loan. The terms of fixed-rate mortgages can range from 10 to 30 years.
Good faith estimate
An estimate made by the lender that breaks down the closing costs due from the borrower at the mortgage closing. Although it’s not exact, it’s a good way for the lender to inform the borrower of how much they’re required to pay at the closing table.
Home inspection
A part of the mortgage process that determines the condition of a home. During a home inspection, a professional home inspector closely examines the home looking for wear, damage, and hazards—anything that could affect the buyer’s investment. This may take much longer than the appraisal and is very thorough. The home buyers are welcome to be present for the home inspection but it is not required. The home buyers will hire their own inspector in order to protect their best interests. The result is a final checklist that the buyers can use to negotiate repairs with the seller.
Homeowners insurance
A form of property insurance that covers losses or damages to a person’s home and assets within the home. The borrower is required to secure homeowners insurance before the mortgage closing date. The homeowners insurance policy must list the lender as the loss payee in the event of fire, flood, or other event where the home or assets in the home are damaged.
Loan-to-value (LTV) ratio
This is a calculation a mortgage lender uses to express the ratio of a mortgage loan to the value of the home. The LTV ratio is calculated by dividing the loan amount by the value of the home. It’s used to measure risk—the higher the LTV ratio, the riskier the mortgage is from the lender’s perspective. This doesn’t necessarily mean the borrower will be denied a mortgage. Sometimes, it means the lender will charge a higher interest rate or require the borrower to purchase mortgage insurance.
Origination fee
This is the cost to originate a mortgage. During the mortgage application process, the borrower may be required to pay an origination fee. This may include application, underwriting, and processing fees. It generally costs between 0.5% and 1% of the total mortgage loan amount.
Principal
This term is used to describe the loan amount of the mortgage. As the borrower makes payments on the mortgage, the principal balance goes down. The other three main things included in a mortgage payment (aside from principal) are interest, taxes, and insurance.
Private mortgage insurance (PMI)
Insurance that protects the lender against losses in case the borrower defaults on their mortgage. Mortgage insurance is usually required if the borrower’s down payment is less than 20% of the purchase price.
Settlement costs
(Also called settlement fees or closing costs.) Various costs associated with the closing of a mortgage. This can include discount points, an appraisal fee, title search and insurance, taxes, survey, deed recording fee, credit report charge, and more. Prior to closing, the attorneys involved in the mortgage closing will meet to determine the final costs that are associated with the loan. These settlement costs are disclosed to all parties before the closing table so that they can be prepared to pay.
Title insurance
Insurance that protects the home buyers and the mortgage lender against defects or problems with title transfer. Since the lender is using the home as collateral for the transaction, title insurance helps them be certain that the title of the property is clear of any liens which could jeopardize the mortgage.
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