Common Mortgage Terms and What They Mean
Adjustable Rate Mortgage (ARM): A mortgage with an interest rate that can change according to a schedule outlined in the Note (Note Rate). The interest rate is based upon an index that changes based on the market, plus a margin which is determined by the lender. Often, the initial interest rate is lower than that of a fixed-rate mortgage.
Appraisal: A professional evaluation of a home’s market value, required by the lender to secure home financing.
Amortization: The act of paying off (as a mortgage) gradually, usually by periodic payments of principal and interest or by payments to a sinking fund
Annual Percentage Rate (APR): The annual equivalent of the rate shown in your Note (Note Rate) plus any other fees paid at closing or throughout the life of the loan, such as monthly mortgage insurance. APR allows borrowers to compare different mortgages when shopping for a lender.
Buydown: A lump sum payment made at the time of closing that prepays interest on the loan for a set period of time. As an example, a 3-2-1 buydown reduces the interest rate the monthly principal and interest payment (P&I) is based upon by 3% the first year, 2% the second year, and 1% the third year. Starting with the fourth year the payment is based upon the rate shown in the Note. Buydowns may be paid by the borrower, seller, lender, or a third party.
Construction Loan: A short-term loan to finance the building phase of a real-estate project.
Credit approval: A preliminary decision by the lender indicating that, based upon credit, assets and employment, the borrower qualifies for a mortgage at a specified rate, term, and amount. Credit report, bank statements, pay stubs, and W-2s have been reviewed by an underwriter. Additional documentation may be required as well as confirmation that the information has not changed in a derogatory manner prior to closing. This does not include an appraisal. This may be obtained prior to searching for a home and is more formal than a Prequalification Letter.
Points: Points are fees paid which decrease the loan's interest rate, with the cost of each point equal to 1% of the loan amount. This means that a loan with points paid at closing will have a lower interest rate than one where no points have been paid. Points may be deductible on your tax return for the year your loan closed. Consult your tax professional.
Down Payment: The difference between the sales price and the loan amount on a real estate transaction. The down payment is brought to the closing by the buyer along with other fees to be paid at that time.
Down Payment Assistance Program (DPA): Programs which provide additional funds, usually to first-time homebuyers, which reduce the amount of cash needed to close. These may be in the form of a grant, requiring no repayment; forgivable seconds, which only require repayment for a certain period or if certain events happen (e.g., if you sell your home); repayable seconds, which typically have a low (or, in certain cases, no) interest rate which must be repaid. The period prior to repayment varies, usually between 3 and 30 years.
Earnest Money or Escrow Deposit: A deposit required at the time a contract is accepted, demonstrating good faith intent of purchasing the home. This is usually held by the title or escrow company until closing.
FHA Loan: A loan insured by the Federal Housing Administration open to all qualified home purchasers. There are limits to the size of FHA loans, but they are usually generous enough to handle moderately-priced homes.
First Time Homebuyer Program: Mortgage loans with special qualifying terms for those who have never owned real estate or have not in the past few years. Although the programs and terms vary by state, they often offer down payment and closing cost assistance.
Fixed-Rate Mortgage: A mortgage in which the interest rate does not change during the loan term.
Index: A benchmark set in financial markets which is used to determine the interest rate on an adjustable-rate mortgage. The index plus a margin set by the lender are added together to determine the fully indexed rate. This is the rate that payment changes will be based upon throughout the term of the loan.
Lien: A legal claim against a property that must be paid when the property is sold.
Lock-in: A written agreement guaranteeing the homebuyer a specified interest rate provided the loan is closed within a set period of time.
Margin: The amount a lender adds to the index on an adjustable rate mortgage to establish the adjusted interest rate.
Mortgage Insurance: A fee typically paid by the borrower to provide insurance in the event of default on the loan. Required on most loans with less than a 20% down payment.
Prequalification: The process of determining how much money a prospective homebuyer will be eligible to borrow before a loan is applied for.
PITI: Acronym for total monthly housing expense: principal, interest, taxes, and insurance.
Title Insurance: Title insurance protects a real estate owner or lender against any loss or damage they might experience because of liens, encumbrances, or defects in the title to the property, or the incorrectness of the related search.
Underwriting: The process of evaluating a loan application to determine the risk involved for the lender.
USDA Rural Home Loan: A USDA Guaranteed Loan is government-insured 100% purchase loan. These loans are only offered in rural areas and serviced by direct lenders that meet federal guidelines.
VA Loans: Fixed-rate loans guaranteed by the U.S. Department of Veterans Affairs. They are designed to make housing affordable for eligible U.S. veterans.