Buying a home is both an exciting and stressful time for most people. Going through the mortgage process can definitely add to that stress.
Finding the perfect home is the easy part. Next comes making an offer, contract negotiations, selecting the right mortgage loan, getting an inspection and appraisal, packing to move, and the final closing.
Dealing with the sellers, realtors, loan officer, appraiser, and mounds of paperwork can be overwhelming, especially for first-time homebuyers. The mortgage process has its own lingo, and you should be well-informed on the terms of your loan and associated costs. You also want to financially prepare so you can get the best rates and house for your budget.
Here are some key mortgage terms that can help demystify the mortgage process:
Amortization: A loan schedule that outlines how the loan will be repaid, with a breakdown of your monthly payment and how much is going to the loan balance versus interest. Early payments cover mostly interest. The longer you pay, more of your monthly payment goes toward principal.
Annual percentage rate: The APR reflects the cost of your mortgage loan as a yearly rate. It is higher than your loan’s interest rate because it includes interest, mortgage insurance plus fees and any other one-time costs associated with the loan. The APR helps you compare apples to apples, mortgage-wise since different lenders have varying interest rates and costs.
Appraisal: This is a report made by an appraisal company or qualified third-party that details a property’s estimated value based on size, location, features, amenities, acreage, and more.
Assessed valuation: The value set by your local taxing authority, either a city or county, to determine property taxes.
Adjustable-rate mortgage: A mortgage with a variable, or adjustable, interest rate according to a pre-selected index. Known as an ARM, this type of mortgage has a fixed interest rate for a set period, typically one to five years, and then adjusts at set intervals.
Fixed-rate mortgage: The interest rate and terms on a mortgage are fixed for the length of the loan, typically from 10 years to up to 40 years.
Down payment: The money you put down toward your home’s purchase usually paid in cash or from a 401k or investment account. A solid down payment helps reduce what you finance and build equity in your home. While a 20 percent down payment is not required, it helps to avoid private mortgage insurance and reduce your total monthly payment. There are special programs that offer low and no down payments. Conventional loans range from 5-20 percent. Government-backed mortgages range from 3.5-10 percent. The required down varies depending on your lender and type of loan.
Loan estimate: This helps homebuyers understand the total cost of a mortgage, compare lenders, and to shop for the best loans. Applicants should receive the estimate within three business days of applying. It outlines the specified loan amount and terms, interest rate (including the APR), estimated monthly payments, estimated assessments, insurance and taxes, and the estimated cash needed at closing.
Earnest money: A deposit, delivered with a purchase offer, you put down to essentially hold the home and bind a real estate sale. Earnest money is generally 3% to 5% of the home’s cost. It goes into an escrow account until you secure financing and gets credited to the purchase price. There is an option period that allows earnest money to be refunded, but the deposit is usually non-refundable if you back out after the window or the sale falls through.
Escrow: A process where a neutral third party handles legal documents and money for a seller and buyer. For example, the earnest money goes into escrow until the purchase is complete. Your lender can also set up an escrow account for homeowners’ insurance and property taxes. A portion of each mortgage payment goes into the account to cover those expenses.
Origination fee: Charges the lender tacks on for processing your mortgage application and underwriting and funding the loan, among other things. This fee is typically 1% to 6% of the loan amount.
Closing costs: The money you need to close the mortgage transaction. These fees add up and can include the origination fee, credit report fees, title insurance, lender charges, real estate commissions, transfer taxes and recording fees, attorney’s fees, and tax and insurance escrow payments. Closing costs range between 2% to 5% of the purchase price, which translates into $4,000 to $10,000 on a $200,000 loan.
FICO score: A measure of consumer credit risk that lenders use to determine interest rates, credit card, and loan limits, or whether you even qualify for a loan. The score can vary among the three main credit bureaus and is based on the information each bureau keeps on file about you. Scores range from 300 to 850. A score above 800+ is exceptional; 740 to 799 is very good; 670 to 739 is good and represents the median credit score range.
Debt-to-Income ratio: This ratio factors in your monthly debt payments versus your gross monthly income. Lenders use DTI to determine how much of a mortgage you can afford. Most mortgage loans cap a max DTI ratio at 41 percent. It also gives you an idea of your maximum home price when you begin house hunting.
Loan-To-Value ratio: This describes the ratio between the value of your home loan and the home’s value. To calculate your LTV, divide your loan amount by the home’s appraised value or purchase price. Lenders evaluate your LTV when they underwrite a loan, and this is where a large down payment or buying a home for less than it is worth can help. A lower LTV ratio helps you qualify for lower mortgage rates. Most lenders require the LTV ratio to be at least 80 percent.
Loan principal: The amount of money that is borrowed for a mortgage. After interest charges, the principal balance will go down when borrowers make regular monthly or bi-weekly payments.
Preapproved or pre-qualified: While the true definition can vary among lenders, this notification means that the lender has deemed you worthy of a loan. Some may request basic information, while others check out your credit score, income and job history. Getting preapproved signals to sellers that you are serious about buying a home. In a hot housing market, it gives you an advantage when putting in a bid.
Private Mortgage Insurance: Most lenders require borrowers carry mortgage insurance on the loan. Known as PMI, this protects the lender in case you default on the loan. Generally, it’s required for borrowers who put down less than 20 percent and ranges between 0.35% to 1% of the loan amount annually. When you have 20% equity in your home, you can ask that PMI be canceled. Mortgage insurance is also required for government-backed mortgages, but terms and payment options vary depending on the type of loan.
Title Insurance: The lender requires title insurance since the bank is using the home as collateral to underwrite the loan. This ensures that the title of the property is clear of any liens, which could make the deal fall through.
Truth in Lending: This federal mandate establishes rules that all lenders must follow, including proper disclosure of rates, how to advertise mortgage loans, and other details of the loan process. These regulations were created to protect consumers from potential fraud.
Worth The Work
A home is one of the most important and long-term purchases you will make. It’s worth doing your homework, shopping around for lenders and loan rates, and understanding the details of your mortgage. There are many factors that go into calculating your monthly mortgage payment. You want to be an informed consumer before signing on for a 15- or 30-year loan because it can have financial ramifications for years to come.
The caring and committed realtors at Core Realty Partners will do their part to make the home buying and mortgage process as smooth and stress-free as possible. Call us today to start the search for your new home!