Refinance, Equity, Appraisal: How to Speak Mortgage 101
Mortgages may seem to have a language all their own. Whether you’re a veteran homeowner or looking to buy a home for the first time, you may want to keep this mortgage 101 glossary handy.
Adjustable-Rate Mortgage (ARM)
An ARM is a mortgage with interest rates and payments that may vary, says Trulia. How frequently it varies depends on the borrower’s specific mortgage.
An appraisal is an estimate of the value of property made by a qualified professional, called an “appraiser,” for the purpose of evaluating a property to help determine the financing options, says Trulia.
When a property legally trades hands, it is called the closing. Also called settlement, this is the meeting between the buyer, seller and lender or their agents, during which property titles are exchanged for funds and closing costs are paid, says the Consumer Financial Protection Bureau (CFPB).
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Closing costs refer to expenses over and above the price of the property that are incurred by buyers and sellers when transferring ownership of a property. Closing costs normally include charges for title insurance and escrow costs, appraisal fees, etc. These costs will vary by locality and the providers used, although they usually total about 2 to 5 percent of the mortgage amount, says Zillow.
A conventional loan is a mortgage not insured by the Federal Housing Administration or guaranteed by Veterans Affairs, says Trulia.
Your debt-to-income ratio is your total monthly debt, divided by gross monthly income and shown as a percentage, says the CFPB. Total monthly debt can include monthly mortgage payments as well as student loans, car loans, and credit card payments.
If your debt equals $2,000 and your gross monthly income equals $6,000, the debt-to-income ratio would be $2,000 divided by $6,000, or 33 percent.
A down payment is the difference between the purchase price and the mortgage amount, often expressed as a percentage, says Zillow. For example, a 20 percent down payment on a $230,000 home is $46,000.
A deposit made in good faith when you make an offer on a home is called earnest money, says the Department of Housing and Urban Development (HUD). The money is generally applied to the down payment at closing.
Also referred to as the owner’s interest, equity is the difference between the fair market value (what the property is worth) and current indebtedness (what is owed to the lender), says the City of Lincoln, Nebraska. This is the amount the owner would be left with after paying off any mortgages or liens, if the property was sold for market value.
Property’s Current Market Value = $200,000
Mortgage Loans and Liens = $150,000
Owner’s Equity = $50,000
Escrow is an account held by the lender into which the homebuyer pays money to cover tax or insurance payments, says the CFPB. For example, the homebuyer pays $120 to the lender every month over and above the mortgage payment. The lender holds that money in an escrow account, and every six months the lender can pay out $600 from the account for property taxes and $120 to a homeowners insurance provider. Escrow can also refer to “earnest money” deposits requested by the seller and held by a third party before closing, says Trulia.
Federal Housing Administration (FHA)
The FHA provides mortgage insurance on loans provided by the FHA-approved lenders, says HUD. FHA financing may feature lower down payments, closing costs, and no prepayment penalties.
A fixed-rate mortgage is one for which the interest rate and monthly principal payment remain the same, or are “fixed,” for the term of the loan, says CFPB.
The fee charged for borrowing money is called interest, and it is usually expressed as a percentage, says the CFPB.
Mortgage Insurance Premium (MIP)
MIP is the up-front insurance premium and monthly charge you may pay if you pay less than 20 percent of a down payment on the home, says CFPB. The insurance may help cover the cost of reselling your home if you default on the mortgage.
Prepaid interest assessed at closing by the lender is referred to as points or loan discount points. Each point is equal to one percent of the loan amount (i.e., two points on a $100,000 mortgage would cost $2,000), says Trulia. Borrowers can pay points to potentially obtain a lower interest rate on the loan. In some cases, sellers may pay points in order to help make the transaction more attractive to the buyer.
Principal, Interest, Taxes and Insurance (PITI)
The four components of a monthly mortgage payment, says Trulia. Principal refers to the part of the monthly payment that reduces the remaining balance of the mortgage. Interest is the fee charged for borrowing money. Taxes and insurance refer to the monthly cost of property taxes and homeowners insurance, whether these amounts are paid into an escrow account each month or not, says CFPB.
Private Mortgage Insurance (PMI)
When buying a home with less than a 20 percent down payment, borrowers are usually required to carry private mortgage insurance to help protect the lender from the costs of a possible default, says CFPB. Private mortgage insurance can often require an initial premium payment and may require an additional monthly fee depending on your loan’s structure.
A rate lock is a lender’s guarantee that the mortgage rate quoted may be good for a specific number of days from the day of application, says CFPB.
Refinancing is obtaining a new mortgage loan on a property already owned, typically to replace one or more existing loans on the property, says the Federal Reserve.
Subprime refers to a class of mortgages offered to customers whose credit history may be insufficient to qualify for a conventional loan, says the CFPB. Subprime loans can typically carry higher interest rates and may include prepayment penalties.
A title is a legal document that gives evidence of property ownership, says Trulia.
This is a contract where the insurer agrees to pay the insured a specific amount for any loss caused by errors in the title to the property. Title insurance for the lender is mandatory and the charge is part of closing costs. The buyer can also choose to obtain coverage, says the CFPB.
An examination of municipal records to help determine the legal ownership of property is called a title search. According to Zillow, this is usually performed by a title company.
Veterans Affairs (VA) Loan
The Department of Veterans Affairs can guarantee home financing featuring little or no down payment and other favorable terms for eligible veterans, reservists and surviving spouses, says the VA. VA financing, also called a VA loan, is available from selected lenders that use VA-approved appraisers.
Verification of Employment (VOE)
A VOE is a document signed by the borrower’s employer verifying his or her position and salary, says the Society for Human Resources Management.
Buying a home can be tricky, especially when the mortgage lenders and real estate agents are using acronyms you’ve never heard before. Hopefully, this list can help you be better prepared on your journey to homeownership.
Originally published September 10, 2010.