Welcome to the world of home buying and mortgage shopping. Does it sound like people are speaking to you in a foreign language? If your ears are untrained in “mortgage-speak”, allow us to "translate" ten of the basic concepts that all new homebuyers should understand.
- Adjustable-Rate Mortgage (ARM) – Instead of repaying a mortgage at a fixed rate, ARM payments adjust over time based on a fixed margin plus some changing index. "Hybrid" mortgages have a short fixed rate period, often five years, with an adjustable remainder of the loan term.
- Escrow – An account established by a borrower at closing to cover various mortgage bills and expenses. The lender uses these funds to pay the bills specified at closing – typically property tax and private mortgage insurance (PMI).
- Loan Estimate Form – The Loan Estimate form replaces the old Good Faith Estimate (GFE) and the Truth-In-Lending (TIL) form that you would have received within three business days after submitting your loan application. This form summarizes your loan terms and estimates as best as possible the expected costs over the life of your loan.
- Closing Disclosure – This form replaces the HUD-1 form and updated TIL form. It contains a summary of the final loan terms, financial information, and cash flows at closing. You receive it three business days before the closing settlement meeting when all of the legal documents are signed.
- Debt-to-Income Ratio (DTI) – The ratio of your debt to your mortgage amount. Your front-end DTI addresses only housing costs, but most lenders review the back-end DTI that includes all debts, including credit cards and other loans. Typically this needs to be below 36-39% to qualify for a mortgage.
- Loan-to-Value Ratio (LTV) – The amount of your mortgage loan divided by the value of your home. 80% is preferred but some mortgages allow higher ratios. LTV and DTI are two of the main measures lenders use to assess your ability to repay, and what interest rates to charge you based on your risk.
- Amortization Schedule – The schedule of how your loan is to be repaid, showing the monthly payments and how much of the payment is devoted to principal (the amount of money you borrowed) and how much is devoted to interest. This shows how much principal you will have paid, and therefore how much of your home you actually own (also known as your equity).
- Points – In a casino sports book, “points” is what the team you’re wagering on gets -- or gives up -- on a given bet. This has nothing to do with mortgages, but might come in handy the next time you are in Vegas. In “mortgage-speak”, points are the money you pay at closing in exchange for a lower interest rate over the life of the loan. Each point equals 1% of the loan, and drops your interest rate by some negotiated percentage (currently around ¼ - ½%).
- Annual Percentage Rate (APR) – A measure of all the costs over the life of the loan as a percentage, including mortgage payments, fees and closing costs. It is used as a guide to compare loans with different terms.
- Closing Costs –All of the costs that are due at closing, including points, appraisal and survey fees, title search and title insurance to verify ownership, taxes, attorney's fees, loan origination fees that cover the lender's paperwork costs, inspection fees, recording fees, homeowners insurance and PMI.
(Note: Homeowner's insurance is your insurance to guard against damage to the house; PMI is insurance you pay the lender to guard against your default, usually required with less than 20% down payment. PMI may be required but homeowner's insurance is always required.)
Hopefully, this article can jumpstart your understanding of mortgage terminology and concepts. You should also find and work with an experienced loan officer who can further demystify this important process. If you’re not familiar with the verbiage, don’t hesitate to ask, or you could end up missing a great deal, or signing up for a poor one.