The ABC’s of Buying a Home: An Explanation of Common Mortgage Terms

Buying a new home can be overwhelming. Knowing the common terms used by lenders and real estate agents will help you feel more comfortable through the process of buying a new home. Below are a number of these terms with an explanation of what they mean to the homebuyer.

Amortization: Paying a mortgage loan back month by month. A set number of payments are established and each payment includes principal and interest. Depending on the amount of your loan, payments are spread out for a set time period and at the end you will own your home.

Annual Percentage Rate (APR): A rate that is calculated using a formula to include interest, points and other fees, the annual percentage rate shows you how much it is costing you per year to utilize the lender’s money.

Appraisal: An appraisal is done to establish the value of a piece of property that is put on the market. Lenders want to ensure that the loan they are granting to you will be backed up by valuable property should you be unable to pay back the loan. As the buyer, you will pay for an appraisal and have the appraisal submitted to your loan company.

ARM: An ARM is short for Adjustable Rate Mortgage. This loan is a variable loan that has an interest rate that goes up and down. There are types of ARM’s, and a popular ARM is a 5 year adjustable rate mortgage. The rate of the mortgage remains the same for five years and then can go up and down based on current market trends.

Balloon Mortgage: A low rate mortgage for a shorter period of time than a typical 15 or 30 year mortgage. Once the loan matures, the balloon payment (what is left of the loan) is due to the lender. Borrowers can either pay off the mortgage at this time or refinance another mortgage.

Cash reserves: Sometimes a lender wants assurance that the borrower has some cash in the bank to ensure that they will be able to pay their mortgage payments on time. This is an amount that is above and beyond closing costs and a down payment. The lender can set an amount they want to be in reserve in order for the borrower to be approved for the loan.

Certificate of title: A legal document that proves home ownership. When a title is transferred through a sale, the property will need to be free of all financial obligations. When a lien has been placed on the property, the seller will have to clear up their debts before they can transfer the property to a new owner.

Closing: This is the best part of buying a house. A closing is settlement time and it is when the property is officially transferred from the seller to the buyer. The buyer will receive the title and pays all closing costs.

Closing costs: These are costs above the standard costs for buying a new property. The costs can include attorney’s fees, points from the bank for the loan, fuel adjustments and real estate taxes. All of these costs will be outlined to you prior to the closing when you sit down and meet with a lender to discuss the terms of your mortgage loan.

Commission: The payment your real estate agent receives for coordinating the purchase or sale of your home. Most of the time this payment is a percentage of the purchase or sale price and is paid at the closing.

Debt-to-income ratio: The debt to income ratio compares how much money you make monthly to your expenses. The point of figuring out a debt-to-income ratio is to see how much you can afford monthly without getting in over your head with a mortgage payment that is too high. If you obtain an FHA loan, your mortgage payment can’t exceed more than 29% of your gross income.

Deed: This is simply the document that transfers property from one owner to another. This document is recorded, along with the mortgage documents, at your local registry of deeds.

Down payment: The amount of cash you pay to the seller that is not part of the mortgage loan. A down payment can be used to decrease monthly payments or to own 20% of your home at the time of sale. When you own 20% of the home you can avoid personal mortgage insurance.

EEM: An acronym for Energy Efficient Mortgage. This type of mortgage is an FHA loan program that allows homebuyers to add the cost of making the house more energy efficient into the home loan. This program assists buyers with instant monthly savings on their utility bills.

Equity: How much of your home you actually own. The equity is the how much your house is worth (or its fair market value) minus the amount you still owe on your mortgage loan. Borrowers sometimes take out home equity loans to improve their property with the idea that improvements will increase the value of the home.

Escrow account: Your property taxes, homeowner’s insurance and mortgage insurance are all paid by your mortgage lender with funds that are in the escrow account. This is a separate account that is set up by the lender and each month a portion of your mortgage payment goes into this account.

Fair market value: What your home is worth to a typical buyer in the current market. The fair market value of a home can be determined by looking at comparable homes in the area that have sold recently, assessing the condition of the property, and taking into consideration the number of similar properties for sale at the same time.

FHA: Short for the Federal Housing Administration, this agency was established to make home ownership more accessible to all citizens in the United States. Instead of a buyer having to pay for personal mortgage insurance, those that qualify for FHA will have their loan insured by FHA. Lenders who may not otherwise provide loans to lower income families are more likely to provide mortgages sponsored by FHA because they are covered if the loan is not paid back.

Fixed-rate mortgage: A basic mortgage where the payments stay the same through the entire loan. All terms of the mortgage remain fixed and are not subject to current rate fluctuations in the market.

Good faith estimate: This is an estimate of all potential fees that you may face at the closing. The lender has three days to provide you with an estimate of all costs once you submit your loan application. This estimate includes costs that the lender is charging you for providing the loan.

Home inspection: A detailed report is provided by a home inspector that walks through the home, looking for signs of structural damage or repair needs. The home inspection is a vital piece to buying a home as this is when a potential buyer learns about any repairs the home may need and can negotiate with the seller either to make the repairs or provide financial compensation.

Homeowner's insurance: This is insurance that protects the homeowners should a person get injured in their home, or should the home sustain property damage from any number of accidents or disasters. Homeowner’s insurance provides money to repair the home should a covered incident occur. Insurance policies differ and you will need to check out the specifics of your homeowner’s insurance policy to see what damages will be covered in the event of an emergency.

Interest: A fee charged by the lender for you to borrow their money.

Lien: When a lien has been placed on a piece of property, the lien must be paid off when the property sells. Liens can occur for any number of reasons, but a lien is a financial obligation of the seller and it must be cleared before the title can transfer to the new owner.

Mortgage insurance: Insurance that protects the lender, generally required when a loan is for more than 80% of the value of a home. Mortgage insurance ensures that the lender will get paid if the borrower is not able to continue paying their mortgage. Once the borrowers have 20% equity in their home they can cancel their mortgage insurance.

Offer: Official only when in writing, an offer is placed when a buyer wants a piece of property and the buyer offers the seller an amount they are willing to pay for the home for sale.

Origination fee: The amount charged by a lender for creating the loan, completing employment checks, and verifying all loan information. This is an amount that is generally paid at the closing.

PITI: An acronym for Principal, Interest, Taxes, and Insurance. These are the four parts to a monthly mortgage payment. Principal directly decreases the amount still owed on the loan, interest covers the cost of borrowing the money, and the rest goes into the escrow fund to cover taxes and insurance. Early on in the loan, most of the mortgage payment goes towards interest. This ensures that the lender receives their interest payments first. Paying extra monthly on your mortgage loan will go towards principal and can significantly decrease the amount of interest you pay over the life of the loan.

Principal: The total amount you borrowed in order to purchase your home. The principal amount is the amount you owe back to the lender and does not include interest or other fees.

Refinancing: Finding one loan to pay off the debt from another loan. Homeowners will sometimes refinance their home in order to get a better interest rate or to avoid a variable rate mortgage that is about to change rates.

If you are not sure what a term means or where a fee came from as you are looking over all of your real estate documents, just ask your real estate agent. You are entitled to know everything about your loan and the home you are buying. If you do not understand the process you may make mistakes that cost you money in repairs or hidden fees.

Allison Van Wig©.