So, you’ve decided to buy a home. You’ve found the perfect property and your offer was accepted. (Congratulations!) Now you’re ready to apply for a home loan. There’s just one small wrinkle: you don’t speak mortgage-ese.
It’s not unusual to be confused by all the jargon, especially if you’re a first-time homebuyer. Lucky for you, adding just a few terms to your vocabulary can help make the mortgage process smoother.
Before you fill out a home loan application, get to know these 11 terms:
1. Private Mortgage Insurance
Private mortgage insurance, or PMI, is a special type of insurance lenders require you to get when you put down less than 20 percent on a conventional home loan, which is a mortgage that’s not backed by a government agency, like the Federal Housing Administration (FHA) or the Department of Veterans Affairs.
PMI protects the lender in case something happens, and you default on your mortgage payments. Depending on how your loan is structured, you might pay a single up-front PMI premium when you close, a monthly premium, or both. Monthly premiums are rolled into your regular mortgage payment.
2. Mortgage Insurance Premium
Essentially, a mortgage insurance premium (MIP) is the same thing as PMI, only it applies specifically to FHA loans. Homebuyers pay an up-front MIP and an annual one, which is broken down into 12 payments and added on to their mortgage.
There are two big differences between PMI and MIP. First, you can avoid PMI by making a down payment of at least 20 percent. This isn’t possible for FHA loan borrowers who typically only put down 3.5 percent.
Second, you can drop PMI once you reach 20 percent equity on a conventional mortgage. With an FHA loan you pay MIP for the life of the loan, unless you put down more than 10%
One big thing lenders look at is your debt-to-income ratio (DTI). This is the percentage of your income that goes towards paying off debt (existing debt like credit cards, student loans, car loans, etc. plus your new mortgage payment) each month. You can calculate your DTI by dividing your total monthly debt payments by your gross monthly income.
In most cases, your total DTI needs to be 43 percent or less to qualify for a mortgage. It’s possible to get a home loan with a higher DTI, but in exchange, you could end up paying a more expensive interest rate on your mortgage.
4. Rate Lock
At some point during the mortgage process, your lender might offer you a rate lock. This means pretty much what it sounds like: it’s a chance to lock in your interest rate when you close within a specific window.
The biggest upside of a rate lock is that your rate won’t change; if interest rates go up before your closing date, you’re guaranteed the lower rate. But, a rate lock can be a disadvantage if rates go down. Another potential negative? If you don’t close on time, your lender might charge you a fee to extend your rate lock.
5. Escrow Account
Buying a home is more than just paying a mortgage; you’ve got other add-ons that you’re financially responsible for, like property taxes and homeowner’s insurance premiums. You could pay for these expenses out of pocket, but it’s usually easier to roll them into your mortgage payment. That’s where your escrow account comes in.
When you make a mortgage payment, not all of the money goes towards your principal and interest. Some of the funds go into a separate account — an escrow account — that your lender manages for you. When your homeowner’s insurance premiums, PMI or MIP, or property tax comes due, the lender pulls the money out of escrow and pays those bills for you.
6. Closing Costs
You pay some costs as you go through the mortgage process: appraisal, inspection and pest inspection fees. Most other fees come at the end.
Closing costs cover everything else involved in finalizing your mortgage. Before you can collect the keys to your new home-sweet-home you have to pay:
- Loan origination fees
- Attorney fees
- Credit check fees
- Title insurance
- Prepayments for homeowner’s insurance and property taxes
- Recording fees
- Survey fees
- Up-front fees for PMI or MIP
- Loan application fees
- Postage and/or courier fees
Generally, closing costs run between 2 and 5 percent of the home’s purchase price.
7. Amortization Calendar
An amortization calendar shows you how long it’ll take to pay off your mortgage, how much of your payment goes to the principal, interest and escrow each month, and how much you’ll pay in interest altogether. The main benefit of checking out your amortization calendar is that it gives you a fairly precise idea of your mortgage’s total cost.
The interest rate is the rate your lender charges you for a mortgage. Your APR, or annual percentage rate, is the annualized cost of borrowing when your interest rate, broker fees or loan points are factored in. (A point is a fee you pay to the lender at closing to lower your interest rate.)
9. Conforming Loan
Conforming loans get their name because they “conform” to guidelines set by Fannie Mae and Freddie Mac, which both provide financing to mortgage lenders. Conforming loans are designed for borrowers with excellent credit and they may offer better rates than non-conforming loans.
10. Fixed-Rate Mortgage
A fixed-rate mortgage has a fixed interest rate. That means your rate stays the same and doesn’t change. Added bonus: you get a predictable monthly payment.
11. Adjustable-Rate Mortgage
An adjustable-rate mortgage (ARM) has an interest rate that can change over time. Most ARMs have an initial, low fixed rate. Then after three, five, seven, or 10 years, the rate adjusts. ARMs can offer lower monthly payments to start, but if your rate rises, your amount due could end up being greater.
Getting a mortgage shouldn’t be a hassle — or require learning an entirely new language. Fortunately, having a good grasp on these few terms should help you make sense of it all.
The Ally Home Team® can help take the mystery out of the home buying process.