November 22nd, 2019 8:20 AM by Jackie A. Graves, President
You’ve found your dream home, which means
it’s time to start the mortgage process.
If you find yourself overwhelmed and confused by all the mortgage terms out
there, don’t worry because you’re not alone. Getting a mortgage can be a
complicated process, made worse by all the unfamiliar terminology your mortgage
lender might use.
For many it can seem like a foreign language, and creates many questions about mortgage terms. Never fear, this quick
primer will help you understand some of the mortgage terms that you might
encounter and what role they play in the mortgage process.
If you have a down payment of less
than 20%, your lender might require private mortgage insurance (PMI). PMI is
insurance that offers protection to your lender if you fail to make your
monthly mortgage payments and default on the loan. If your mortgage comes with
PMI, then you should be able to have it removed once your loan-to-value ratio
(see the next paragraph) reaches a certain level. The level typically needed to
have PMI removed is 78% of your home’s value.
The LTV is a ratio that divides the amount
of money you’re borrowing for the home by the total value of the property. The
larger your down payment, the lower your loan-to-value ratio is. When
originating a mortgage or refinancing, lower loan-to-value ratios—80% and
below—usually mean more favorable interest rates for you, the buyer.
Total Property Value
Lenders use LTV to assess their risk on
extending you a mortgage. Higher LTVs indicate a higher risk of default. That
risk is based on the loan being for nearly as much as the value of the
property, so there is little, if any, equity for you, the lender to fall back
on in case of foreclosure.
An adjustable rate mortgage is a mortgage product that
uses a fixed rate for a certain loan term—typically 3, 5, 7 or 10 years. The
interest rate on an ARM is usually lower than the rate you receive on a
fixed-rate mortgage, also known as a conventional mortgage.
However, once the fixed period of an ARM loan term is over, the rate variably
adjusts up or down, depending on current interest rates.
A conventional fixed-rate mortgage of one
of the more popular products for home buyers. It takes any uncertainty out of
your loan. The rate for a fixed-rate loan stays the same until you either pay
off the loan or refinance it. If your rate is 4.125% the day you close the
loan, it will stay at 4.125% until you pay the loan off or refinance for a
The downside of fixed-rate mortgages is
that they tend to come with higher interest rates than adjustable-rate
mortgages. Plus, you won’t be able to take advantage of interest-rate declines.
A fixed-rate mortgage, however, does offer you protection against rising
A jumbo loan is a mortgage for an amount greater than the limits set by the Federal
Housing Finance Agency (FHFA). These limits are referred to as the
maximum conforming loan limits and change annually. They set limits on the
amount a mortgage can’t go above and still be purchased by Fannie Mae (the
Federal National Mortgage Association) or Freddie Mac (a government-owned corporation that buys
mortgages and turns them into mortgage-backed securities). In most areas of the
U.S., jumbo loans apply to luxury properties. In 2019, values can’t exceed
$726,525 or 150% of the limit of $484,350.
Many lenders require a larger down payment for a jumbo
loan. Plus, lenders tend to want borrowers on jumbo loans with a credit score of at least 700. Find your credit score for free on Credit.com.
FHA loans let
borrowers purchase a home with a lower down payment than a conventional loan.
They are also available for lower interest rates than conventional fixed-mortgage
loans. FHA loans are insured by the Federal Housing Administration, which is
part of the Department of Housing and Urban Development. With an FHA loan,
there’s more flexibility in the borrower’s credit score, and borrowers can have
scores at low as 500. FHA loans, however, do typically require mortgage
insurance with an upfront premium and annual premiums.
The annual percentage rate (APR) is the
rate you’re charged to borrow the money for your mortgage loan. APRs are shown
as percentages. That percentage is the amount you pay on top of the loan amount
for borrowing the funds. It includes your interest rate, finance charges and
fees, so it is higher than the interest rate itself. For example, if your loan
is 400,000 at an interest rate of 4.125%, your APR might be 4.157% for 30
years. You would pay 697,895.22 for the 400,000 loan. The APR is where the
added 297,895.22 comes from. It’s the cost you’re charged to borrow the money.
The federal Truth in Lending Act requires
all lenders to tell the potential borrower what the APR is. Because fees and
finance charges vary by lender, APRs can vary by lender as well, even for the
same interest rate.
Discount points or mortgage points are fees you can pay
at closing to reduce the interest rate on your mortgage.
It is also known as buying down the rate. The more points you purchase, the
lower your interest rate will be. Points typically cost 1% of the loan amount.
That means if you purchase a $300,000 home, one point will cost $3,000. You’re
basically prepaying interest at the time you get the loan by buying points.
Here’s a quick illustration of how discount
points can help your long-term cost of buying a home with a 400,000 mortgage.
Cost of Point(s)
Savings on 30-Year
Within three days of submitting a home loan
application to a lender, the lender has to give you a good faith estimate
(GFE). The term GFE was replaced by the current term, the Loan Estimate and
Closing Disclosure Form, in October 2015. The GFE details exactly what the
closing costs will be on your loan, including fees, title charges and more.
Getting a GFE from a lender doesn’t obligate you to take that lender’s loan.
The servicer is the one that sends mortgage
statements, collects loan payments and distributes payment for items such as
insurance and property taxes. While you might receive your loan from one
company, a different company might be the one that services the loan.
When you hear the term PITI, it’s referring
to your total monthly mortgage payment, which can include loan principal, loan
interest, property taxes, homeowners insurance and/or mortgage insurance (PMI).
After you submit your application for a home loan, it
goes to the underwriting department.
This department ensures it has all necessary documents to complete your loan.
It then assesses your application, how risky you are to loan money to and
whether or not to approve your loan. It considers your credit score, assets,
employment and other factors when making its decision.
These are fees charged by the lender to
cover their costs to process your loan. Most lenders charge an origination fee
of .5% to 1% of the total loan value.
As you consider different lenders and
negotiate terms, interest rates can fluctuate based on market conditions. Once
you choose a lender and agree with its terms, you want to lock in your interest
rate. This is known as a mortgage rate lock. It ensures your rate won’t go up
between the time you lock it in and you close, which usually takes four to six
weeks. The potential downside is that the interest rate may go down and you’ll
be locked in to a higher rate.
Part of your monthly mortgage payment goes to paying real
estate taxes and insurance. This money is typically placed into an escrow
account and then distributed on a set schedule. Zillow defines escrow as
“when an impartial third party holds on to something of value during a
transaction.” Throughout the mortgage process, different transactions at
different times are held by a third party. For example, your earnest money,
which is a deposit that tells the seller that you intend to buy the home,
doesn’t go to the seller, but is held by a third party until you close on the
house. If you don’t, it goes back to you.
Escrow also comes into play with your
lender, who pay your PITI expenses from your monthly mortgage payment. The
lenders holds those funds in escrow and makes the payments for you.
Escrow can happen as closing as well. An
escrow officer will give out all the needed funds to the different parties to
ensure your mortgage closes and you get the key to your new home.
This term refers to the process of
spreading out a loan into equal monthly payments for a term, such as 15 or 30
years for a mortgage. The payment includes both the interest and principal as
well as other costs potentially. The actual interest and principal paid each
month changes as more money goes to the principal over time. However, your
monthly payment stays the same.
For example, for a sample loan with a starting
balance of $20,000 at 4% interest, the monthly payment is $368.33. The
principal accounts for $301.66 of that, the interest accounts for $66.67 and
the balance after your first payment totals $19,698.34. For your thirteenth
payment, $313.95 goes to the principal and $54.38 goes to interest.
The shifts or amortization happen behind
the scenes—although you should be given an amortization schedule by your
lender, so you can see the shifts. Your very last payment will likely be less
than your monthly payments and will pay off the remaining balance of the loan.
If you fail to make payments on this type
of loan, you see an increase in the principal balance of the loan, which is
known negative amortization. The loan payment shouldn’t be less than the
interest charged for that particular period. To avoid fees and higher interest,
you want to avoid negative amortization.
Balloon mortgages don’t fully amortize over
the term of the loan. Instead, they have a balance the date the loan
matures—the date of the final payment. That balance is large and is for the
principal only. Interest will have been paid out of the monthly payments. The
final payment of the loan is a balloon payment. Having this type of mortgage
loan is more common in commercial real estate than in residential real estate.
Debt-to-income ratio (DTR) is used by
lenders to assess risk. Your ratio is your total debt divided by your income.
If you have a higher debt-to-income ratio, it’s harder to get approved for a
loan, because a mortgage lender will see you as a risk. In most cases, a 43%
debt-to-income ratio is the highest a mortgage lender will consider before
approving a mortgage application. However, the ideal percentage for your DTR
should fall under 28% on the front-end, which is how much of your gross
income goes to housing costs, and no more than 36% on the back end, which
includes all of your monthly expense. The generally term, DTR, usually
encompasses the back end where front-end DTR is considered a variation of the
You can calculate your debt-to-income ratio with the Credit.com Debt-to-Income (DTI) Calculator.
To protect consumers from inaccurate and unfair credit
billing and practices, the Truth in Lending Act (TILA) was
created. The federal law passed in 1968 to ensure that lenders treat consumers
fairly in the lending marketplace. It includes the requirement of disclosures
regarding terms and costs and an explanation to how these costs associate with
the borrowing process and how they get calculated.
Knowing these terms can make the mortgage
process much easier and more transparent for the borrower. Securing a mortgage
loan is one of the biggest transactions a person can make in their lifetime
which makes it all the more important to understand the process from beginning
to end to give you the confidence you need when signing the papers for your new
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