There's a lot to learn when you’re buying a home; it can be an intimidating process. Give yourself an advantage by making sure you understand these basic mortgage terms and definitions.
Basic mortgage terms and definitions
1. Annual percentage rate (APR)
Lenders like Global Credit Union Home Loans typically publish two different mortgage rates for the same mortgage. The APR is usually the higher of the two; it shows how much you'll actually pay on an annual basis, including closing costs, points, and other lender fees.
2. Mortgage interest rate
This percentage shows how much you'll pay in interest for just your principal mortgage loan, not including any fees. This rate can be either fixed or variable.
3. Escrow account
You can set up your mortgage so that a portion of each payment goes into an escrow account each month and is used to pay for property taxes and homeowner's insurance. An escrow account can also be used to hold your earnest money until the deal closes.
Bonus definition: Earnest money is a deposit made into an escrow account held by the real estate broker or title company to demonstrate that you're serious about buying a house. It is typically applied to closing costs or your down payment at closing.
4. Mortgage servicer
This company handles the day-to-day administration of your loan; they receive payments, send monthly statements, and manage your escrow account.
5. Private mortgage insurance (PMI)
This insurance, required until you have at least 20% equity in your home, protects your lender if you default. PMI costs range from 0.15% to 2% or more of your monthly payment.
Lenders go through an in-depth underwriting process to verify your income, assets, debt, credit history, and property details (i.e., appraised value) before approving or denying your loan application.
7. Title insurance
A title proves legal ownership of a property, and title insurance protects you against outside claims that would impact your ownership. You only need to pay for title insurance once, at closing, and the insurance remains in place for long as you own the home.
Your home-buying process will go more smoothly if you get preapproved for a mortgage. This process tells you how much you'll be allowed to borrow; preapproval also lets sellers know you are a serious buyer.
This process is less exact than preapproval; it's an estimate of how much you'll be able to qualify for, based on some basic financial information.
10. Debt-to-income (DTI) ratio
Lenders look at your DTI when they consider your mortgage application; it indicates how well you will be able to manage the monthly payments. Lower is better.
DTI % = monthly expenses (loans, credit card debt, rent, etc.) ÷ gross monthly income (before taxes)
11. Household income
Most lenders limit monthly mortgage payments to 28% of your household income. So, if you have an annual household income of $75,000, your monthly mortgage payment should not be higher than $1,750 ($75,000 x 0.28 ÷ 12).
An appraisal is a market inspection done by an independent, professional appraiser that gives a lender an estimate of the value of the property.
13. Loan-to-value (LTV) ratio
The ratio of your loan amount versus the appraised value of your property is called LTV. Lenders use LTV to determine whether you can qualify for the loan.
LTV % = mortgage amount ÷ appraised property value
14. Closing costs
Also called settlement costs, these are the fees you must pay to finalize your mortgage loan. They include things like title search, appraisal, loan origination fees, title insurance, escrow fees, and others. Closing costs can add 3-6% to your loan total.