11 Mortgage Terms Homebuyers Should Know
Key Takeaways
Unless you work in the industry, you probably won’t know the meaning of every word you hear.
If you don’t understand what your lender is saying, ask them for clarity.
You can call us anytime if you feel in over your head.
Mortgage Term Glossary
Interest Rate
An interest rate is a percentage that represents the money a borrower pays their lender in exchange for getting a mortgage to cover the cost of their home purchase. Interest rates can be fixed (also called a mortgage rate lock), where it never changes throughout the life (or term) of the loan. Or they can be variable, meaning the interest rate can change at set points through the duration of the loan (also called an Adjustable Rate Mortgage or ARM).
Term
A mortgage term is the agreed upon length of time for the borrower to pay back the loan. Typically loans are repaid over 10, 15, 20, or 30 years. Usually, you’ll hear mortgages described by the type of interest rate (fixed or variable) plus the term. For example: 30-year fixed rate mortgage.
Mortgage Down Payment
A mortgage down payment is the amount of money the homebuyer pays upfront (excluding any closing costs or other prepaid taxes, insurance, or interest) towards purchasing the home. Down payment requirements typically range between 3% to 20% of the value of the home, but some specialty programs allow for no down payment at all. The #1 reason cited by renters who want to own their own home, but don’t, is difficulty saving for the down payment*. If you want help thinking of ways to save for your down payment, check out our guide on Understanding Your Finances.
Escrow Account
An escrow account is a special account your lender sets up when you get your loan to pay things like property taxes, homeowners insurance, mortgage insurance, and homeowner association dues. Since these things are typically paid only once or twice each year, your lender can compute how much you need to pay monthly to cover these items, collect it from you each month, and deposit it into your escrow account. This money belongs to you, but the lender holds it for you to ensure there’s enough in the account to pay the various bills when they come due. If you pay off your loan for any reason, the lender will return any remaining balance to you shortly after the loan is paid in full. Having an escrow account may be optional depending on the specific loan program you choose as well as the amount of down payment you elect to make.
Monthly Mortgage Payment
When a lender discusses the monthly mortgage payment, they are usually referring to the principal and interest (or P&I) portion of the payment owed each month. There are additional costs beyond P&I, which may include taxes, homeowners insurance, and mortgage insurance. Use our mortgage payment calculator to see what your mortgage payment could be using current rates.
Private Mortgage Insurance (PMI)
Private Mortgage Insurance may be required for some mortgages if the buyer’s down payment is less than 20% of the purchase price of the home. The amount varies based on the chosen lender and mortgage product, but will typically range between 0.30% to 1.15% of your loan balance each year. Federal law requires that PMI be removed from your monthly payment once the Loan-To-Value Ratio (LTV) on the loan reaches 78% for most programs, however some programs like FHA may require mortgage insurance for the entire term of the loan.
Loan-To-Value Ratio (LTV)
The loan-to-value ratio is a percentage that shows the amount of money being borrowed compared to the total value of home. As an example, if a homeowner wants to buy a home valued at $100,000 and is able to make a down payment of $20,000—they would need an $80,000 loan to purchase the home, and have an LTV of 80%.
($80,000/$100,000) X 100 (to get a percentage) = 80% LTV
As you begin making payments and the balance of your loan begins to decrease, your LTV ratio will naturally begin to decrease as well. Your lender always uses the value of your home that was determined when you took out the loan to compute the LTV ratio.
Pre-Approved & Pre-Qualified
Before looking at homes to buy, it’s a good idea to find a lender who seems like they’ll be willing to loan you the necessary funds to purchase the home. To become pre-approved or pre-qualified a lender may ask for financial information like monthly income and monthly debt, so they can calculate your debt-to-income ratio (DTI) and determine how much to approve the buyer to borrow. We explore the differences deeper in this article.
Debt-To-Income Ratio (DTI)
A debt-to-income ratio is a measure of a person’s total monthly payments for debts they owe, divided by their total monthly before tax (or gross) income. Some of the most common monthly debt items included in the calculation are student loans, credit card debt, car loans, and other mortgages. As a general rule of thumb, lenders like seeing a DTI ratio less than 49%. It’s a useful figure when trying to determine how much home you can afford.
Annual Percentage Rate (APR)
APR is a measure of the additional costs beyond the interest rate that impact how much a buyer pays over the term of the loan. It represents the annual cost of the loan and includes the interest rate, mortgage insurance, and certain closing costs. However, the APR does not include things like property taxes or homeowners insurance since those items are not paid to the lender and you would incur these costs even if you didn’t take out a loan for the home.
Closing Costs
Closing is when the mortgage is finalized, paperwork is signed, and funds are transferred from the lender so the buyer can purchase the home. The closing costs are all the costs associated with this process, and can include an origination fee from the lender, title search and insurance fees, document preparation, attorney fees, required home inspections, appraisal fees, credit reports, etc. Closing costs may vary considerably from one lender or loan program to another. As a rough estimate, you could expect them to run about 3% of the total loan amount, but you’ll want to check with your lender since there are several factors that influence the costs. It’s important to remember that you’ll need enough funds to cover both the down payment amount and any closing costs. In some cases, you may be able to include a portion of your closing costs in the loan you’re taking out. Regardless of whether you’re buying a home or refinancing an existing one you’ll incur closing costs, although you may find the costs to be slightly less on a refinance transaction.
Provided in partnership with Member Advantage Mortgage
