Home Loan Lingo
Do you know what a loan-to-value ratio is? You’re not alone. When it comes to the mortgage process, there are many terms that can leave even the most seasoned homeowners confused. To take some of the mystery out of this intimidating process, we’ve created a list of common home loan terms.
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An adjustable-rate mortgage (ARM) is a mortgage loan that remains at a fixed interest rate for a set amount of time. After that period is over, the interest rate of an ARM loan changes at regular intervals to match the current market rates. The borrower may start with lower monthly payments, but when the interest rate changes, the monthly payments can increase significantly. Alternatively, it is possible the payments could go down as well.
Simply means repaying a loan by making equal periodic payments that include both principal and interest until the loan is paid off. Most home loans amortize. But some don’t. If the loan doesn’t amortize, the borrower could owe a large lump sum after the loan term is complete (a balloon payment).
The annual percentage rate is the annual rate of interest paid for the life of a loan and contains lender’s fees and other charges. It is usually higher than the straight interest rate and is a better representation of what a borrower will actually pay.
An appraisal is a professional estimate of a home’s fair market value. It is determined by examining the home’s location and condition and stacked against recent sale prices of comparable properties in the area.
A basis point is 0.01% or 1/100th of 1%. Interest rates can change by small amounts and talking about these changes in basis points makes the small changes clear. For example, if a home loan has a 5% interest rate and it increases another 2%, does that mean that we calculate 2% of the 5% and add it on top, like this: 0.05 x (1 + 0.02) = 5.10%, or does that mean 5% + 2% = 7%? Talking about these changes in basis points clears up the confusion. If the interest rate changed by 10 basis points, that would be a 0.10% increase.
Cash to close is the total amount a home buyer brings to the closing appointment. It usually includes all the closing costs, down payment (minus any earnest money already put down), pre-paid taxes, homeowner’s insurance, and any homeowners association fees or other fees, if applicable. This is paid by wire transfer ahead of time, or by a certified bank or cashier’s check brought to the closing appointment.
This is the final step of the homebuying process. At the closing appointment, all outstanding fees are paid (everything associated with closing costs and other cash to close), documents to transfer ownership of the property from the seller to the buyer are signed, the mortgage loan is signed, and the title is registered in the buyer’s name.
Otherwise known as settlement costs, closing costs are the cost of obtaining a home loan. Title search fees, title insurance, appraisal fees, credit report charges, loan origination fees, and others that make up the cost of the mortgage loan and are reported in detail on the loan disclosures. They are also factored into the annual percentage rate (APR) which represents the true cost of the mortgage loan.
The buyer pays the closing costs and the mortgage down payment, along with any other cash to close needed, at the closing appointment by certified check or wire transfer.
The closing disclosure is a document that describes in detail all the important terms of a mortgage loan. This will include the interest rate, purchase price, loan fees, monthly payments, estimated real estate taxes, homeowners insurance, and all other closing costs. It is very important that the buyer review this document closely and discuss any questions with their lender.
A conforming loan is a type of conventional mortgage that meets the funding criteria of Fannie Mae and Freddie Mac (federally backed mortgage companies) and can, therefore, be sold on the secondary mortgage market. These home loans usually have lower interest rates than other types of mortgage loans and cannot exceed a certain dollar limit.
A contingency is a condition that is added to the real estate contract that must be met by the buyer or seller before either is obligated to move forward with the sale. These conditions protect both parties in the event that something unexpected happens. For example, if the home is appraised for less than the buyer is offering to pay, or if they are unable to secure a loan, a contingency could allow the buyer to back out of the sale. On the seller’s side, it could be a contingency stating that if they cannot find a place to move to within a certain period of time, they are not obligated to sell.
A conventional mortgage is the most common form of home loan. Conventional mortgages are backed by private mortgage lenders and are not guaranteed or insured by the federal government. The credit requirements needed to qualify for a conventional mortgage are usually stricter than for government-backed loans, but they tend to have overall loan costs that are lower than other types of mortgage loans.
Credits, or lender credits, are funds the mortgage lender can give to the borrower to lower their closing costs. This is done in exchange for an increase in the interest rate on the mortgage loan.
The debt-to-income ratio is calculated by taking the total of a person’s monthly debt payments and dividing it by their monthly gross income (pre-tax). This helps a lender nail down the monthly mortgage payment the borrower is likely to afford.
The down payment is the amount a buyer pays upfront for the cost of a new home. The remaining cost is financed by their home mortgage. Usually, when a buyer has a larger down payment, they can get a lower interest rate on their home mortgage and are more likely to be approved for the mortgage loan. If the buyer provides less than 20% for the down payment, they are likely to be required to pay for private mortgage insurance (PMI), causing their monthly payments to be larger.
Earnest money is the amount of money the buyer provides when the sales contract agreement is signed as proof of their intent to purchase the home. The earnest money is deposited into an escrow account, where it stays until the closing. At the home closing, the earnest money can either go towards the closing costs or towards the down payment. If the sale is canceled for an allowable reason, the earnest money is returned to the buyer. However, if the contract falls through because the buyer did not act in good faith, the seller keeps the earnest money.
Equity is the amount of ownership a homeowner has in their property. This can be calculated by taking the current market value of the home and subtracting the amount they still own on their mortgage.
An escrow account, or impound account, is a bank account set up by a mortgage lender to hold a home buyer’s deposits during the process of a home purchase. The earnest money, down payment, mortgage funds, and other monies are all put into the escrow account until the sale is complete and the title is transferred to the new owner. It is from this account that the seller and all applicable parties are paid for the sale of the home. After the sale of the home, many lenders use an escrow account to collect a certain amount from each mortgage payment to pay property taxes and insurance premiums on behalf of the owner.
Government-backed loans with more relaxed credit requirements. FHA loans require Mortgage Insurance Premium (MIP) for the lifetime of the loan. They require only a 3-5% down payment and have more relaxed credit requirements.
A fixed-rate mortgage is a home loan that has a fixed interest rate that remains unchanged for the life of the loan. It is most beneficial for buyers who plan on living in their homes for ten or more years.
Before a mortgage lender will approve a home loan, they will require a flood certification document, which states whether or not the home is in a flood zone. If the home is in a flood zone (as determined by FEMA flood maps), the buyer will be required to purchase flood insurance for the home.
If a buyer has been given money by a family member or significant other to pay for all or part of the down payment or closing costs on a home purchase, the lender will require a gift letter to be submitted. This letter assures the mortgage lender that this money was indeed a gift and is not expected to be repaid. Without this letter, the money could be considered debt and will alter the buyer’s debt-to-income ratio.
The interest rate is the cost of borrowing money and is a percentage of the total home loan. If the interest collected is simple interest, only interest on the principal is paid. If compound interest is collected, interest is paid on both the principal and on any accumulated interest.
With an interest-only mortgage, a homebuyer’s monthly payments can only be applied towards the loan interest for a specified amount of time. The principal payments are deferred until later. However, no home equity is built through interest-only monthly payments. This can be a good option for those who will refinance or sell their home within just a few years.
Jumbo loans are loans that are larger than the usual conforming loan limits. Conforming loans have a loan-size ceiling that adjusts based on housing costs in an area. Jumbo loans allow a buyer to borrow more money than this limit, but they also require a higher down payment and more loan documentation.
Conforming Loan limits are at a set base of $647,200 but have higher limits in some counties where housing is more expensive. In the Denver Metro Area, this amount is $684,250. View Loan Limits for 2022
A lien is a legal right to possess someone else’s property until their debt is paid. When a buyer takes out a mortgage loan, the mortgage lender has a lien on that property, meaning they have a legal right to seize possession of the property if the buyer doesn’t make their mortgage payments.
The loan amount is the total amount of money loaned by a mortgage lender to a home buyer for the purchase of a home. Home loan amounts vary based on income, monthly debts, down payment, and credit score.
The loan commitment proves a borrower’s eligibility to secure a home loan. It is a written statement from a lender that the borrower qualifies for a specific loan amount, and the lender promises to give that loan if all the stated terms and conditions are met. Since the loan commitment is given after a loan application has been approved, it carries more assurance than a pre-approval letter.
A loan estimate (LE) is an important document that provides information about the loan details, such as interest rate, closing costs, loan term, and monthly payment amount. A lender must provide the LE to a borrower within three days of receiving a mortgage application. The LE allows a borrower to compare loans from different lenders easily.
The loan-to-value (LTV) ratio is an equation that compares the mortgage loan amount to the appraised market value of the property. If the loan is for more than 80% of the appraised market value, a lender will often require the borrower to purchase private mortgage insurance.
The mortgage insurance premium (MIP) is mortgage insurance required on all Federal Housing Administration (FHA) loans. It protects the lender should the borrower fall behind in their home loan payments.
A nonconforming loan does not meet the funding criteria of Fannie Mae and Freddie Mac (which are federally backed home mortgage companies). They are higher-risk loans for lenders and, therefore, usually come with higher interest rates. Some examples of nonconforming loans are jumbo loans, USDA loans, VA loans, and FHA loans.
Origination fees are fees the lender charges to the borrower to cover the costs of creating the home loan. Costs such as processing the loan, underwriting, and funding all take time and require labor, which is, in part, recouped by the lender through origination fees.
PITI is an acronym that represents the four elements that are rolled together into a monthly mortgage payment. These elements are principal, interest, taxes, and insurance.
Points represent a type of fee that the borrower can pay to the lender in exchange for a lower interest rate on the mortgage loan. One point equals 1% of the mortgage loan. The more points the borrower pays, the lower their interest rate can be.
The pre-approval letter is an official document that states how much a lender is potentially willing to loan you based on the information you provided in your pre-approval application. Having this letter can prove to a seller that you can likely secure the finances needed to purchase the home. However, it is not a guarantee of final home loan approval or amount.
Prepaid costs are payments a buyer makes into an escrow account at the time of the home closing. These payments cover certain home costs that may accrue before you make your first mortgage payment, such as mortgage interest, homeowners insurance, and property taxes.
A prepayment penalty is a fee that some lenders charge for paying off part or all of a mortgage loan early. Not all mortgages have a prepayment penalty, and it must be made clear to the borrower if a prepayment penalty is included in the mortgage terms or not.
Private Mortgage Insurance (PMI) is a type of insurance that a lender often requires if a borrower has made a downpayment of less than 20% of the value of the home. PMI protects the lender if the borrower should default on the mortgage and is added to the monthly mortgage payments. However, once the borrower owns a certain amount of equity in the home, PMI may be canceled.
Refinancing a mortgage loan means trading in an old home mortgage loan for a new one with different terms. The lender then pays off the original mortgage with the new loan amount. Homeowners often refinance to lock in a lower interest rate or to exchange some of the equity they have built in their home for cash.
Third-party fees are paid as a part of the closing costs for other services that do not involve the mortgage lender. These could be for appraisals, property surveys, transfer taxes, credit reports, and more.
A property title is a legal concept representing who holds the ownership rights to a property. The deed is a written legal document that can transfer the title from one person to another.
There are two types of title insurance: lender’s title insurance and owner’s title insurance. A lender often requires a borrower to purchase lender’s title insurance to protect the lender from financial loss due to problems that may arise with the title. This is usually a one-time fee that is paid as part of the closing costs.
Owner’s title insurance can also be purchased by the new homeowner but is not required. It protects the homeowner should an undiscovered lien on the property come to light after the property is purchased or if the homeowner is sued for ownership rights to the property.
Underwriting is the process by which a home loan application is assessed by a lender and either approved or denied. The underwriter will look at the appraised value of the property and the verified information provided in the loan application, which shows the borrower’s ability to repay the loan. If the potential loan is determined to have an acceptable risk to the lender, it will be approved. If it is determined to be too risky, it will be denied.
A wire transfer is a transfer of money directly from one bank to another. This is an electronic transaction that is often used for large transfers of money. A wire transfer is useful in the home buying process for such things as paying earnest money or making a down payment.