When embarking on the journey of buying a home, understanding the terminology related to mortgages is essential.
The mortgage process can be complex, and knowing the right terms will not only make you more informed but also more confident in your decisions.
This ultimate glossary covers 30 key mortgage terms that every homebuyer should know.
Let’s dive into each term, breaking down its meaning and implications to empower you on your path to homeownership.
Adjustable-Rate Mortgage (ARM)
An Adjustable-Rate Mortgage (ARM) is a type of home loan where the interest rate changes over time. Initially, borrowers pay a fixed interest rate for a specific period—typically 5, 7, or 10 years.
At the end of the fixed period, the interest rate can adjust periodically throughout the rest of the loan term. Depending on market conditions, the adjustment can lead to higher or lower monthly payments.
An ARM is expressed as two numbers (i.e. 5/1 or 10/6):
- First Number: refers to the length of time the rate is fixed
- Second Number: indicates how often the rate will change after the fixed-rate period ends
With a 5/1 ARM, for example, you’ll receive a fixed rate for the first five years of the loan. Then, based on several factors, the rate may increase or decrease once a year for the rest of your loan term.
ARMs are attractive to some borrowers because they often start with lower rates than fixed-rate mortgages. However, the uncertainty of future rate adjustments can pose a risk if interest rates rise significantly.
Amortization
Amortization refers to the process of gradually repaying a mortgage loan over time through scheduled, periodic payments. Each payment is split between paying down the loan’s principal and covering the interest.
In the early stages of the loan, a larger portion of each payment goes toward interest. Over time, as the principal balance decreases, more of each payment goes toward reducing the loan’s principal. Understanding amortization is key to knowing how your mortgage payments are structured and how quickly you’ll build equity in your home.
Annual Percentage Rate (APR)
The Annual Percentage Rate (APR) represents the total yearly cost of a mortgage, including interest and other fees, expressed as a percentage. The APR is a more comprehensive measure than the interest rate alone.
Your APR includes your interest rate, any points, mortgage broker fees, and other charges you pay to get the loan. When comparing mortgage offers, the APR gives you a clearer picture of the true cost of the loan over time.
Closing Costs
Closing costs are the fees and expenses you pay when finalizing the purchase of a home. These costs can include lender fees, title insurance, attorney fees, taxes, and prepaid items like homeowner’s insurance.
Closing costs typically range from 2% to 5% of the loan amount. While some costs are negotiable, it’s crucial to budget for these expenses to avoid surprises at the closing table.
When you apply for a mortgage, the lender will hand you a loan estimate that lists all your closing costs. Some of these include:
- Appraisal fees
- Origination fees
- Title insurance
- Survey fee
- Credit report fee
Closing Disclosure
The Closing Disclosure is a five-page document provided to homebuyers at least three business days before closing on a mortgage. It outlines the final terms and costs of the loan, including:
- Annual percentage rate and interest rate
- Projected monthly payment
- Closing costs
- Lender Fees
Review your closing disclosure carefully and compare it with your loan estimate. It ensures there are no surprises and that all terms align with what you agreed upon with your lender. If anything has changed or you have questions, ask your lender before you go to the closing table.
Conventional Loan
A Conventional Loan is a type of mortgage that is not insured or guaranteed by the federal government. These loans typically require a higher credit score and a larger down payment compared to government-backed loans like FHA, VA, or USDA loans.
Conventional loans often come with fewer restrictions and may offer more favorable terms for borrowers with strong credit profiles. Conventional loans can either be conforming or non-conforming. Here’s a quick breakdown of how these types of loans differ:
- Conforming Loans – fit within financing limits set by the Federal Housing Finance Agency. In most of the country, that limit is $766,550 for one-unit properties.
- Non-Conforming Loans – have a balance that exceeds the conforming limit. These are also called jumbo loans, and because Fannie Mae and Freddie Mac won’t buy jumbo loans, they often come with higher interest rates than conforming loans.
Debt-to-Income Ratio (DTI)
A Debt-to-Income Ratio (DTI) measures how much of your monthly income goes toward debt. Lenders use DTI to assess a borrower’s ability to manage monthly mortgage payments. It is calculated by dividing your total monthly debt payments by your gross monthly income.
There are two types of DTI ratios:
- Front-end DTI: Accounts for your housing-related debts, which include costs like your expected new mortgage payment, taxes, and insurance.
- Back-end DTI: Measures all of your debt, including housing costs.
A lower DTI indicates a healthier balance between income and debt and increases your chances of mortgage approval. Most lenders prefer a DTI ratio of 43% or lower for mortgage approval.
Deed
A deed is a legal document that transfers ownership of a property from one party to another. It includes a description of the property and identifies the buyer (grantee) and the seller (grantor).
A mortgage deed allows the bank to put a lien on your property to secure the loan. This means the bank can foreclose on your home if you default on payments.
After you pay the loan in full, the lender records the deed in the county property records office. Once signed and recorded with the local government, the deed serves as proof of ownership.
Discount Points
Discount points are upfront fees paid to the lender at closing in exchange for a reduced interest rate on a mortgage. Each point typically equals 1% of the loan amount. Each point can lower your interest rate by a fraction of a percentage point.
On a $300,000 home, you could pay $3,000 to buy one point. How much the lender lowers your rate will vary, but 1 point usually lowers your rate by 0.25%. Buying points can be beneficial if you plan to stay in the home for a long time, as it can result in significant savings over the life of the loan.
Down Payment
A down payment is the amount of money a homebuyer pays upfront towards the purchase price of a home. It is expressed as a percentage of the total purchase price, with 20% being a common target to avoid paying private mortgage insurance (PMI).
However, many loan programs allow for lower down payments, sometimes as low as 3%, especially for first-time buyers. The size of your down payment can impact your mortgage terms, monthly payments, and the amount of equity you start with, in your new home.
Earnest Money
Earnest money is a deposit made by the buyer as a sign of good faith when entering into a contract to purchase a home. The amount of the deposit varies with every market, but it’s typically equal to 1% to 2% of the home’s listing price.
This money is typically held in escrow and applied towards the down payment or closing costs at closing. If the deal falls through due to contingencies outlined in the contract, the buyer may get the earnest money back. However, if the buyer backs out of the deal for other reasons, the seller may keep the earnest money as compensation for taking the property off the market.
Equity
Equity represents the portion of the home that you own outright. It’s calculated as the difference between the home’s current market value and the outstanding balance on your mortgage.
Building equity is a primary benefit of homeownership. Your equity increases over time as you pay down your mortgage and as the value of your home appreciates. Equity can be leveraged in the future through home equity loans or lines of credit, providing financial flexibility for home improvements or other expenses.
Escrow
Escrow is a financial arrangement where a neutral third party holds funds or documents related to a real estate transaction until all conditions of the sale are met. In the homebuying process, escrow accounts are commonly used when:
- You provide earnest money: When you give earnest money to the seller, your funds will be kept in an escrow account. The funds will be disbursed when you either close on the home or back out of the transaction.
- Your lender collects property taxes and homeowners insurance: The lender will take these costs from your monthly loan payment, keep the money in your escrow account, and pay these bills on your behalf.
Escrow provides security and ensures that both buyers and sellers fulfill their obligations before the transaction is completed.
FHA Loan
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). They are designed to help lower-income and first-time homebuyers qualify for home financing.
FHA loans typically require a lower down payment (as low as 3.5%) and have more lenient credit score requirements compared to conventional loans. However, they also require the borrower to pay mortgage insurance premiums (MIP), which can increase the overall cost of the loan.
Fixed-Rate Mortgage
A Fixed-Rate Mortgage is a type of mortgage where the interest rate remains constant throughout the life of the loan. This stability means your monthly mortgage payment for principal and interest will never change.
The predictability of fixed-rate mortgages makes it easier to budget over the long term. Fixed-rate mortgages are popular among homebuyers who prefer predictable payments and plan to stay in their homes for an extended period.
Home Appraisal
A home appraisal is an independent assessment of a property’s market value conducted by a licensed appraiser. Lenders require an appraisal to ensure that the property’s value lines up with the loan amount.
The appraiser considers factors like the home’s location, condition, and comparable sales in the area. An accurate appraisal is crucial for both buyers and lenders to ensure that they are making a sound financial investment.
If the appraisal comes in below the price of the home, you’ll either need to:
- Negotiate with the seller before moving forward with the mortgage
- Challenge the appraisal
- Request a new appraisal
Home Inspection
A home inspection is a thorough evaluation of a property’s condition. They are typically conducted by a licensed inspector before closing. The inspector assesses the home’s structural components, electrical systems, plumbing, roof, and more to identify any potential issues or repairs needed.
A home inspection provides buyers with valuable information about the property. An inspection report can serve as a basis for negotiating repairs or price adjustments with the seller.
Interest Rate
The interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. In a mortgage, the interest rate determines how much you will pay the lender in addition to repaying the principal.
Interest rates can be fixed or adjustable, and they are influenced by factors such as market conditions, the borrower’s credit score, and the loan type. Understanding your interest rate is crucial because it directly impacts your monthly payments and the total cost of the loan over time.
Jumbo Loan
A Jumbo Loan is a type of mortgage that exceeds the conforming loan limits set by the Federal Housing Finance Agency (FHFA). Because these loans are larger and riskier for lenders, they often come with stricter credit requirements and higher interest rates.
Jumbo loans are typically used to finance luxury homes or properties in high-cost areas. Borrowers considering a jumbo loan should be prepared for a more rigorous approval process.
Loan Estimate
A Loan Estimate is a three-page document provided by the lender within three days of receiving your mortgage application. It details the estimated interest rate, monthly payment, and closing costs for the loan.
The Loan Estimate also includes important information such as:
- Estimated interest rate
- Your monthly payment
- Total closing costs
- Estimated costs of taxes and insurance
- Whether the interest rate and payments may change in the future
This document is crucial for comparing different loan offers and making an informed decision about which mortgage is right for you.
Loan-to-Value Ratio (LTV)
The Loan-to-Value Ratio (LTV) is a financial term that compares the loan amount to the appraised value of the property. It is calculated by dividing the mortgage amount by the property’s appraised value and is expressed as a percentage.
For example, say your loan amount is $320,000 and you’re buying a house worth $400,000. Your LTV ratio at the time of purchase is calculated as: ($320,000/$400,000) x 100 = 80%.
Mortgage lenders use this number to measure the risk associated with a mortgage. A lower LTV is generally preferred by lenders as it indicates a lower risk.
Pre-Approval
Mortgage pre-approval is a process where a lender evaluates your financial situation to determine how much you can borrow. Lenders evaluate your credit score, income, debt, and assets—to determine the maximum loan amount you qualify for. A pre-approval letter gives you a clear idea of your home buying budget and strengthens your offer when bidding on a home.
A pre-approval letters shows sellers that you are a serious and qualified buyer. However, pre-approval is not a guarantee of final loan approval, which still requires a full mortgage underwriting process.
Principal
Principal is the original amount of money borrowed in a mortgage loan, excluding interest and other charges. Over time, as you make mortgage payments, the principal balance decreases.
The principal is a crucial component of your mortgage. It directly affects the interest you pay and how quickly you build equity in your home.
Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is a type of insurance that protects the lender if the borrower defaults on the loan. PMI is typically required for conventional loans when the borrower makes a down payment of less than 20% of the home’s purchase price.
PMI can add to your monthly mortgage payment, but it allows you to purchase a home with a smaller down payment. PMI is often cancelable once you reach 20% equity in your home.
Seller Concessions
Seller concessions are contributions made by the seller towards the buyer’s closing costs, prepaid expenses, or repairs. These concessions are negotiated during the purchase process and can help reduce the buyer’s out-of-pocket expenses at closing.
There are limits on how much a seller can contribute, depending on the loan type and the buyer’s down payment. Here are some examples of concessions a seller may pay:
- Mortgage points
- Property taxes (through end of year)
- Appraisal fee
- Inspection fees
- Origination fees
- Title insurance
- Recording fees
- Attorney’s fees
Term Length
Term Length refers to the number of years over which the mortgage loan is repaid. While you can find mortgages with various term lengths, the most popular are 15 years and 30 years.
- Shorter term lengths (15 years) typically come with higher monthly payments but lower total interest costs.
- Longer term lengths (30 years) offer lower monthly payments but higher total interest over the life of the loan.
Choosing the right term length depends on your financial goals and ability to manage monthly payments.
Title
A title is a legal document that establishes ownership of a property. It includes details about the property’s history, including previous ownership, liens, and easements.
In order to transfer a property during a real estate transaction, a clear title is essential. Ensuring that the title is free of any defects or claims is a critical step in the homebuying process. After you close on a home loan, your mortgage will be listed on the title as a lien.
Title Insurance
Title Insurance is a type of insurance that protects homebuyers and lenders from financial loss due to defects in the property’s title, such as liens, encumbrances, or ownership disputes. Title insurance is typically required by lenders and is purchased during the closing process.
It provides peace of mind by ensuring that the buyer’s ownership of the property is secure. There are two main types of title insurance policies:
- Lender’s Title Insurance: protects your lender against problems with the title. Most lenders require you to purchase a lender’s title insurance policy.
- Owner’s Title Insurance: protects you, the homebuyer. This policy is optional but often recommended, as it can protect you from any potential title defects.
USDA Loan
A USDA Loan is a mortgage backed by the U.S. Department of Agriculture. They’re designed to help low-to-moderate income buyers purchase homes in eligible rural areas.
USDA loans offer benefits such as no down payment, competitive interest rates, and low mortgage insurance premiums. These loans are an attractive option for buyers looking to purchase property outside of urban areas and who meet specific income and geographic requirements.
VA Loan
A VA Loan is a mortgage loan guaranteed by the U.S. Department of Veterans Affairs. They’re available to eligible veterans, active-duty service members, and certain surviving spouses.
VA loans offer several benefits, including no down payment, no PMI, and competitive interest rates. These loans are designed to help veterans and their families achieve homeownership with more favorable terms compared to conventional loans.
Wrapping Up Our Glossary of 30 Mortgage Terms
Navigating the mortgage process can be complex, but understanding these key terms will empower you to make informed decisions as you embark on your homeownership journey.
Whether you’re a first-time homebuyer or an experienced homeowner, this glossary will help you navigate the financial side of real estate.
It provides the knowledge needed to confidently move forward with your mortgage and ultimately achieve your dream of owning a home.
If you’re ready to get started on your home-buying journey, Helen Painter Group Realtors is here to offer our expertise and local knowledge.
A long-standing and trusted Fort Worth real estate agency, we’ve been serving buyers and sellers since 1958.
With over six decades of success behind us, you’ll surely have peace of mind knowing your best interests are being represented each step toward buying or selling a home.
To learn more or speak with an agent, feel free to give us a call at (817) 923-7321 or contact us.