Dreaming of finally having a home of your own? We’re here to equip you with the knowledge it takes to begin the search for your perfect home and to understand your mortgage with confidence and ease!
Here are the 10 key terms and definitions you should know before diving into the world of home lending:
- PITI stands for Principal, Interest, Taxes, and Insurance; it is the foundation of a monthly mortgage payment. Principal and interest payments (P&I) work together as the majority of a borrower’s monthly payment; the principal being the portion of the actual balance you have to pay back on the mortgage monthly, and interest being the amount you owe to the lender each month for the funds borrowed. P&I is then trailed by taxes and mortgage insurance to complete the make-up of a monthly mortgage payment.
Interest Rate (Fixed and ARM)
- The interest rate of a mortgage is the percentage amount you will pay each year to borrow from your lender. An interest rate is essentially an agreed-upon commission a lender takes over time for lending you the funds upfront to purchase a home.
- There are fixed and adjustable interest rates in home lending. A fixed-rate mortgage has an interest rate that will not vary or change throughout the life of a loan. An adjustable-rate mortgage (ARM) has an interest rate that is susceptible to change due to rate caps, the introductory period of a loan, and the interest rate index. There are pros and cons to both types of mortgages, it will be up to you and your lending officer to determine which one will work best for you!
- APR stands for annual percentage rate and represents the overall yearly cost of a loan. This percentage will be higher than your interest rate because the APR involves not only the loan’s interest rate but also any fees or additional associated costs.
- Amortization is the act of paying a mortgage monthly so that by its maturity date, the loan will be paid off. An amortization schedule allows you to see your payments each month, how each payment affects the balance of the loan, and how future payments will affect the total amount you owe as well.
- Underwriting refers to the practice of a mortgage lender verifying your income, assets, and debt to determine the final approval status of your loan. Underwriting is crucial to the lending process and essentially determines how much of a risk a lender will be taking on if they decide to lend to you and how much of a risk a loan will be for you as the borrower. They will often need you to provide proof of assets, supplementary documents, or answers specific to any questions they have about your income, assets, or debt. Your lender will use this information to assess your ability to repay, and will endeavor not to make you a loan that you will ultimately not be able to afford.
Pre-qualification & Pre-approval
- Mortgage pre-qualification is an analysis of your income, credit, debt, and assets so that a lender can estimate how much you may be able to borrow. A pre-qualification does not guarantee that you will be approved but is an estimate according to the information you self-report.
- Pre-approval is a formal statement written by a lender to you as a prospective borrower with your specific approved loan amount. The mortgage pre-approval is key to the house hunting process because it gives you an advantage and makes you appear prepared and serious when putting in a home offer. Like a pre-qualification, a pre-approval is not a guarantee that a specific loan on a specific property will be approved. Pre-approval is a longer and more comprehensive process comprised of pulling your financial history, credit score, documentation of assets, etc., making it far more accurate and reliable than a pre-qualification.
Debt to Income Ratio
- Your debt to income ratio is the total amount of monthly debt payments you are committed to, divided by your gross monthly income. DTI ratio is a major factor that lenders use to determine how much you will practically be able to afford each month. Ideally, you should aim to have a DTI ratio on the low end of the spectrum.
- A down payment is an initial amount independently paid towards a home when financing with a mortgage. Usually, a down payment is a percentage of the home’s value and the rest will be covered by the loan. The larger the down payment, the lower the mortgage loan interest rate. A larger down payment will also raise a borrower’s chance of mortgage approval.
- Closing costs encompass all of the costs associated with the final sale of a home. Usually closing costs are around 2 to 6 percent of the home’s purchase price and include property tax, prepaid interest, Home Owner’s Association (HOA) fees if applicable, appraisal fees, lender fees, etc. It’s important to take closing costs into account when you are looking for a home and signing a mortgage.
- Escrow is a legal process in which a third party holds an asset (in a mortgage’s case, the deed to a house) on behalf of the buyer and seller until both parties have fulfilled their contractual obligations. An escrow account can be set up by your mortgage lender and managed by a third party so that part of your monthly mortgage payment can be deposited and left on reserve for property-related expenses for the life of the loan.