Whether you’re a first time homebuyer or a seasoned homeowner, the terminology of mortgages can be confusing. Since buying a home is such a huge financial decision, you’re also going to want to make sure you understand every step of the process and all of the conditions and fees along the way.
In this article, we’re going to explain some of the common terms you might come across when applying for a home loan, be it online or over the phone. By learning the basic meaning of these terms you’ll feel more confident and prepared going into the application process.
We’ll cover the acronyms, like APRs and ARMs, and the scary sounding terms like “amortization” so that you know everything you need to about the terminology of home loans.
ARM and FRM, or adjustable rate vs fixed rate mortgages. Lenders make their money by charging you interest on your home loan that you pay back over the length of your loan period. Adjustable rate mortgages or ARMs are loans that have interest rates which change over the lifespan of your loan. You may start off at a low, “introductory rate” and later start paying higher amounts depending on the predetermined rate index. Fixed rate mortgages, on the other hand, remain at the same rate throughout the life of the loan. However, refinancing on your loan allows you to receive a different interest rate later down the road.
Amortization. It sounds like a medieval torture technique, but in reality amortization is the process of making your life easier by setting up a fixed repayment schedule. This schedule includes both the interest and the principal loan balance, allowing you to understand how long and how much money will go toward repaying your mortgage.
Equity. Simply state, your equity is the the amount of the home you have paid off. In a sense, it’s the amount of the home that you really own. Your equity increases as you make payments, and having equity can help you buy a new home, or see a return on investment with your current home if the home increases in value.
Assumption and assumability. It isn’t the title of a Jane Austen novel. It’s all about the process of a mortgage changing hands. An assumable mortgage can be transferred to a new buyer, and assumption is the actual transfer of the loan. Assuming a loan can be financially beneficial if the home as increased in value since the mortgage was created.
Escrow. There are a lot of legal implications that come along with buying a home. An escrow is designed to make sure the loan process runs smoothly. It acts as a holding tank for your documents, payments, as well as property taxes and insurance. An escrow performs an important function in the home buying process, and, as a result, charges you a percentage of the home for its services.
Origination fee. Basically a fancy way of saying “processing fee,” the origination covers the cost of processing your mortgage application. It’s one of the many “closing costs” you’ll encounter when buying a home and accounts for all of the legwork your loan officer does to make your mortgage a reality--running credit reports, reviewing income history, and so on.
There’s many different myths about buying a home that may have been presented to you as fact. All of these rumors could have you believing that being a home owner is a dream. Here, we’ll debunk some of the most common misconceptions about home buying and give you the tools to solve any issues that you may come across in the process of securing a home loan.
If You Don’t Have 20% To Put Down On A Home, You Can’t Buy
Many conventional loans do require a 20% down payment on a home. There’s also many different loans available that may suit your needs. From Federal Housing Administration loans to Veteran’s programs to down payment assistance programs, there’s many different things that can be done to help you buy a home. Keep in mind that any time you put less than 20% down, you’ll need to provide additional mortgage insurance, also known as PMI or private mortgage insurance.
If Your Credit Score Is Terrible You’re Out Of Luck
If you want really good mortgage rates, having great credit is very important. If your credit score is low, your rates tend to be much higher. A really low credit score could keep you from getting a loan completely. FHA loans allow you to still qualify for a loan with a credit score as low as 580.
You Need To Make Bank To Get Money From The Bank
Monthly annual income is just one of the factors that’s considered when it comes to getting a loan to purchase a home. Your debts matter just as much if not more. People with significant credit card debt and other loans may be denied a home loan even if they have a substantial income.
You’re In The Clear If You’re Pre-Qualified
Pre-qualification is much different than pre-approval. Pre-qualification involves giving your lender basic information about your finances in order to estimate how much of a loan you can get. This will give you a ballpark figure of about how much you’ll be able to borrow. Of course, this is very helpful in the home search process, but you’re not done. To get pre-approved, you’ll need a complete mortgage application in order to have your complete financial background check and credit rating.
If You’ve Met One Real Estate Agent, You’ve Met Them All
This couldn’t be further from the truth. Your relationship with your real estate agent is going to be quite close. You’ll need to share somewhat personal information in order to secure a house you’ll love. Agents are involved in one of the biggest decisions that you’ll ever make. Each agent has his or her specialties and knows different neighborhoods better than others. Definitely go with a real estate agent that you feel comfortable with and knows their stuff.
Closing Costs Aren’t Your Responsibility
Sometimes, sellers do pay the closing costs in the sale of a home. It all depends upon how the negotiations go with the home. You’ll need to be prepared for upfront costs in buying a home. These include a credit check, attorney fees and property insurance. As a buyer, you’ll be paying anywhere between 2 and 5 percent of the purchase price of the home.
It’s important to be prepared and to stay informed in order to make sound financial decisions throughout the process of purchasing a home. Everything will be that much more exciting when you have all of the pertinent information that you’ll need.
Adjustable rate mortgages are also known as “ARM” loans. These are home loans with monthly payments that move up and down along with interest rates and the market. There’s different periods that occur throughout the time of the adjustable loan including an initial period where the rate is fixed for a certain amount of time. The rates will change along with preset intervals of change.
Rates Start Lower Than Fixed Rate Mortgages
Interest rates during the fixed rate period of an adjustable mortgage are usually lower than that of fixed-rate mortgages. The most common type of adjustable rate mortgage is called the 5/1 ARM. This means that the rate is locked for a total of 5 years before it becomes truly adjustable. After the 5 years the rate will change every year. Other forms of ARM loans are the 3/1, the 7/1, and the 10/1.
Rate Indexes And Margins
Following the fixed-rate period, the interest rate adjusts with what’s titled the index interest rate. This rate is set by the market and is released periodically by an independent party. Since there are a variety of indexes, your loan will state which index your adjustable rate mortgage will follow. To set your exact rate, your lender will look at the index and then add a number of percentage points that has already been set in place. This is called the margin. For example, an index rate of 2.5 percent and a margin of 2 will equal an interest rate of 4.5 percent. As the index changes, this number will go up and down.
Adjustable Rate Mortgages Come With Caps
If you do decide to go with an adjustable rate mortgage, you should know that you’re protected from extreme rate increases. These loans come with caps that limit the amount that both rates and payments can change by. There are several different kinds of caps including:
Periodic Rate Cap
This limits the amount that an interest rate can change from one year to the next.
Lifetime Rate Cap
This type of cap limits how much the interest rate can change overall throughout the life of the loan.
Payment Rate Cap
This limits how much the monthly payments can rise over the life of the loan in a dollar amount. This is different than other caps, since it denotes dollars instead of percentage points.
Is This Type Of Loan For You?
Adjustable rate mortgages can be good, depending on the state of the economy and your own financial situation. Stay educated and shop around in order to get the best rates available for you.
Deciphering credit scoresMost major lenders assign your credit score based on the information provided by three national credit bureaus: Equifax, Experian, and TransUnion. These companies report your credit history to FICO, who give you a score from 300 to 850 (850 being the best your score can get). When applying for a mortgage (or attempting to be pre-approved for a home loan), the lender you choose will weight several aspects to determine if they will lend money to you and under what terms they will lend you the money. Among these are your employment status, current salary, your savings and assets, and your credit score. Lenders use this data to attempt to determine how likely you are to pay off your debt. To be considered a "safe" person to lend money to it will require a combination of things, including good credit. What is good credit? Credit scores are based on five components:
- 35%: your payment history
- 30%: your debt amount
- 15%: length of your credit history
- 10%: types of credit you have used
- 10%: recent credit inquiries (such as taking out new loans or opening new credit cards)
What does this mean for taking out mortgages?A higher credit score will get you a lower interest rate. By the time you pay off your mortgage, just a hundred points on your credit score could save you thousands on your mortgage, and that's not including the money you might save by getting lower interest rates on other loans as well. If you would like to buy a home within the next few years, take this time to focus on building your credit score:
- If you have high balances, do your best to lower them
- If you have a tendency to miss payments, set recurring reminders in your phone to make sure you pay on time
- If you don't have diverse credit, it could be a good time to take out a loan or open your first credit card