At Security First Financial, we know home financing can be a little confusing. We want you to feel confident and comfortable about the home loan process, so we’ve listed some common mortgage terms and definitions to help you better understand the process.
Adjustable-Rate Mortgage (ARM)
An ARM is a mortgage with an interest rate that can change throughout the loan term.
ARMs often start with an interest rate that remains the same for several years. After that initial period, the interest rate can change multiple times throughout the life of the loan. Rates are usually adjusted every 6 months but can be changed monthly. Sometimes your rate goes up, while other times it may go down.
Amortization is the process of paying off an obligation over time through a series of fixed payments.
Your loan will be amortized as you pay your mortgage each month. Because of amortization, your monthly payment remains fixed, but the amounts of the payment going to principal and interest may vary from month to month throughout the loan. For example, monthly payments tend to include more interest towards the beginning of your loan term.
Annual Percentage Rate (APR)
APR represents the cost of a loan over a year. It includes the interest rate as well as other costs and fees that come with your loan.
Remember APR adds interest, costs, and fees together. For example, the APR will usually include origination fees.
Closing costs are the expenses associated with completing a real estate transaction. They are usually split between the buyer and seller.
Closing costs vary depending on the loan. Examples of common homebuyer closing costs include an appraisal fee, home inspection fee, loan origination fee, underwriting fee, title insurance, prepaid mortgage insurance, and taxes.
Your debt-to-income ratio, sometimes called DTI, is the percentage of your gross monthly income that goes toward monthly debt payments and obligations.
Your debt-to-income ratio compares your gross monthly income to your monthly debt payments. It factors in things like rent or mortgage payments, auto loans, credit card payments, and alimony/child support payments. It does not usually include utilities, phone bills, monthly subscriptions, etc.
Having a manageable debt-to-income ratio can improve your chances of getting home financing at a good rate.
Earnest money is a deposit put down by a homebuyer to show the seller they’re serious. Once the loan closes, the earnest money goes toward the purchase of the home.
Buyers often put down earnest money as a sign of good faith to show a seller they’re committed to the purchase. Earnest money goes into an account until you close on the purchase deal, then it gets applied toward the home.
Escrow is the term for when a third-party holds an asset until a transaction is complete. During the mortgage process, escrow usually applies to the earnest money.
When you write an earnest money check, it goes into escrow, which means it can’t be accessed by you or the seller until the mortgage closes.
A fixed-rate mortgage is a home loan on which the interest rate remains the same throughout the entire duration of the loan.
If you choose a fixed-rate mortgage, your interest rate remains the same for your entire loan period even if market rates change.
Your home equity is the current value of your home minus what you owe on your mortgage.
After you’ve paid your mortgage for a while, you may build up home equity depending on how property values change. Home equity eventually becomes an asset you can access by refinancing.
Pre-approval is when you get official approval for the amount you can borrow before you make an offer on a home.
If you’re pre-approved for a loan, the lender has officially agreed upon the amount you can borrow. This involves checking your credit report, reviewing financial details and documents, and going through the underwriting process.
Prequalification is when you get a rough estimate of the amount you may qualify to borrow once you apply. You’ll need to provide some basic financial information to prequalify.
Getting prequalified takes fewer documents than getting pre-approved. It doesn’t secure your loan, but it gives you a ballpark estimate for the amount a lender thinks you can afford to borrow.
Private Mortgage Insurance (PMI)
PMI is an expense added to your monthly payment to protect your lender’s investment if you default on your loan. It is normally required if your down payment is less than 20%.
Usually, you pay private mortgage insurance in monthly installments until you build up at least 20% equity in your home.
Title insurance protects against title issues like back taxes, liens, and conflicting wills.
There are two common types of title insurance, one for lenders and one for owners. In both cases, title insurance protects against potential title problems. It’s usually purchased with a one-time payment.
If you’d like to learn more about home financing or apply for a home loan, contact your local Security First Financial Loan Originator!
Original blog post by Primary Residential Mortgage, Inc.: https://www.primeres.com/about/blog/article/2021/01/04/mortgage-terms-to-know-before-you-buy