Mortgage Terms To Know If You’re Getting Ready To Buy A House

Buying a home, especially for the first time, can be a complex and confusing process. You’re likely to encounter lots of new terms that you may not be familiar with. To help pull back the curtain on the mortgage process, we’ve made a list of some of the most important and common mortgage terms you should know.

Key Mortgage Terminology: An Overview

The table below briefly defines key mortgage terms that home buyers should know before starting the loan process. You can find more comprehensive definitions for each of these terms in a later section.

A Closer Look At These Key Mortgage Terms

In this section, you can find more detailed definitions of the mortgage terms introduced in the table above.

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage (ARM) is a type of home loan that offers a lower fixed interest rate for a certain number of years at the beginning of the loan term (say, the first 5 years on a 30-year loan). The interest rate won’t rise for those years. However, after that initial fixed-rate period ends, your interest rate can fluctuate based on the market.

There are safeguards in place to ensure your rate doesn’t rise too high. Rate caps guarantee that your rate can only be raised a certain percentage each year, and a lifetime cap can ensure the rate doesn’t rise above a certain point at any time.

Amortization

Mortgage amortization is the repayment schedule of your loan and shows how the funds are allocated between your principal balance and interest. Your lender should provide a copy of this amortization schedule at your loan closing.

In the beginning, a larger percentage of your monthly payment goes to paying down the interest. As you pay off your loan, your equity grows, and a larger percentage of your monthly payment goes to paying down the principal balance.

Annual Percentage Rate (APR)

Annual percentage rate (APR) is the rate that covers the total amount it costs to borrow money for a mortgage loan. While it’s often confused with your interest rate, your APR includes both interest and any other fees and costs associated with the loan.

APR can include origination fees, mortgage discount points, mortgage insurance fees and other lender fees. Your APR is a little higher than your mortgage interest rate and represents the true cost of borrowing the money.

Closing Costs

Closing costs are the fees associated with a real estate transaction. These usually amount to 3% – 6% of the home’s purchase price, and they must be paid on closing day. Your closing costs are listed in the Closing Disclosure provided by your lender, so you’ll know the amount to bring to the closing. Closing costs can include an origination fee, escrow deposit, title insurance and fees, discount points, transfer taxes and more.

Closing Disclosure

A Closing Disclosure is a document that shows exactly what you’ll need to bring to the closing appointment. This document presents the details of your loan and will list your loan type, interest rate, monthly payment, loan term, down payment and the amount of money you’ll need to bring to the closing.

You’re legally entitled to receive your Closing Disclosure at least 3 business days before your closing appointment so you have time to review it and compare it to your Loan Estimate. If there are any discrepancies, bring them to your lender immediately.

Conforming Loan

A conforming loan is one that falls within the established loan limits set by the Federal Housing Finance Agency (FHFA). Conforming loans are eligible to be purchased by Fannie Mae and Freddie Mac. There is a base conforming loan limit, as well as a higher limit that applies to high-cost areas. A loan that doesn’t meet the conforming loan limits is a jumbo loan.

Conventional Loan

A conventional loan is any mortgage that’s not backed by a government agency. They don’t include government-backed loans like FHA loans, VA loans and USDA loans.

While many people use the terms conventional loan and conforming loan interchangeably, the two aren’t quite the same. A conforming loan is one that meets the loan limits for loans to be purchased by Fannie Mae and Freddie Mac. Many loans are both conventional and conforming, but conventional loans also include jumbo loans, which are non-conforming loans.

Conventional loans are subject to certain lending requirements related to the down payment, your credit score, your debt-to-income ratio and more.

Credit Score

Your credit score gives a simple picture of your financial wellness and shows lenders if you make payments on time, utilize a lower portion of the credit available to you and manage your debt well. A credit score is a three-digit number that ranges from 300 to 850, and the higher the score, the better.

Your credit score can affect which loan types you’re eligible for and what interest rate you qualify for. The higher your credit score, the lower the interest rate you typically can get.

Debt-To-Income Ratio (DTI)

Your debt-to-income ratio (DTI) is used during the mortgage approval process to determine whether you can afford a mortgage payment. DTI is calculated by comparing your minimum monthly debt payments, including credit cards, car payments, student loans and more, with your gross monthly income (before taxes). This ratio is expressed as a percentage.

The lower your DTI, the more likely you’ll be approved for a mortgage. Lenders want to make sure you’re able to make your loan payments.

Down Payment

A down payment is a sum of money you pay upfront when your mortgage transaction is processed. It reduces the amount of money you borrow for your mortgage loan. For example, say you want to buy a house for $250,000 and have a down payment of $15,000. Your loan amount would ultimately be $235,000.

A down payment shows your mortgage lender that you are serious about buying a home. With money invested, you’re less likely to walk away. It also gives you immediate equity in your home, which reduces risk somewhat for the lender.

There are a few loan options with no down payment required, but most home loans require a down payment. Depending on the loan, you’ll be required to pay at least 3% of the home’s total purchase price. It’s a common misconception that you need a 20% down payment, but most loans only require 3% – 5% down. However, putting down less than 20% just means you’ll likely pay a little extra per month in mortgage insurance.

Earnest Money Deposit

An earnest money deposit is a sum of money a buyer offers to pay in their home offer to make it more enticing to sellers. Earnest money, also known as a good faith deposit, helps show the seller that a buyer is serious about the sale.

In fact, some sellers even prefer offers with an earnest money deposit to those without and will sometimes consider a lower offer with an earnest money deposit over a higher one that has nothing to back it up.

Earnest money often ranges from 1% – 3% of the purchase price and ultimately goes toward the buyer’s closing costs or down payment. However, if the buyer backs out for a reason other than one outlined in the sale agreement, the seller gets to keep the earnest money.

Escrow

Escrow refers to a neutral third party that holds onto funds in a real estate transaction until the transaction is complete. It’s designed to protect both buyers and sellers. It’s used to hold a buyer’s earnest money, as well as any other funds that are a condition of the sale.

An escrow account is also used after the home sale and holds a homeowner’s funds for property taxes and homeowners insurance. When you make your monthly mortgage payment, you pay an additional amount for taxes and insurance. That extra money is held for you in your escrow account, and then your lender will pay your taxes and insurance for you.

FHA Loan

An FHA loan is a mortgage that’s backed by the Federal Housing Administration under the U.S. Department of Housing and Urban Development (HUD). FHA loans help to make homeownership more accessible to low- to moderate-income borrowers and those whose credit scores may prevent them from getting conventional loans.

FHA loans have several benefits, including low down payments, low closing costs and low credit score requirements. Like conventional loans, they may also require mortgage insurance in the form of both an upfront mortgage insurance premium (MIP) and an annual MIP.

Fixed-Rate Mortgage

A fixed-rate mortgage is a home loan that charges the same interest rate over the life of the loan. This is a good option for people who want a consistent monthly payment. However, even with a fixed-rate mortgage, your monthly payment can change from year to year as property taxes and homeowners insurance rates fluctuate because these costs are included in your mortgage payment.

Forbearance

Mortgage forbearance is a temporary pause in your mortgage payments due to financial hardship. Lenders offer forbearance to help borrowers get back on their feet when they’re struggling financially, as well as avoid added fees, penalties or a negative impact on their credit report.

Each lender has its own requirements to qualify for forbearance and you’ll usually have to provide detailed financial information to prove that you need it. You’ll still have to make up the payments you missed during your forbearance – they are usually added onto the back end of your mortgage, which extends your repayment period.

Foreclosure

Mortgage foreclosure is the process of a lender taking control of a property when a borrower has failed to make their mortgage payments.

Mortgages are secured loans, meaning the home serves as collateral. The mortgage agreement you sign when you close on your loan gives the lender the right to seize your home if you don’t keep up your end of the deal by making your mortgage payments.

The lender is able to foreclose because of a lien on the property, which is a legal claim against it that can be used to repay a debt. When you take out a mortgage, the lien remains on your house until you fully repay the loan.

Don’t worry – a lender can’t immediately foreclose on your home when you miss a payment. Instead, you’ll receive a notice of default after 30 days of missed payments. Once that happens, you’ll often have several months to make up your missed payments before the lender initiates the foreclosure process.

Home Equity

Home equity is the amount of ownership you have in the home after subtracting your mortgage balance and any liens on the property. It’s affected by the amount of your down payment, the amount left on your mortgage and the housing market conditions.

For example, let’s say you bought a house worth $300,000. You put $15,000 down and have paid off $50,000 of the balance so far, so your equity is $65,000. But let’s say the housing market is doing very well and your house is now worth $325,000. Without paying any additional money, your home equity has increased by $25,000 to $90,000.

Interest Rate

Your interest rate is a charge your lender makes to you to lend the money to buy or refinance your home. This rate is shown as a percentage, and the rate you qualify for will depend on several factors, including your loan type, credit score and the current market rates. Your interest rate is an important component of your monthly loan payment, and the higher your interest rate, the higher your monthly mortgage payment.

Jumbo Loan

A jumbo loan is a type of mortgage that doesn’t fall within the conforming loan limits set by the Federal Housing Finance Agency (FHFA). Because they don’t meet the conforming loan limits, jumbo loans aren’t eligible to be purchased by Fannie Mae or Freddie Mac.

Jumbo loans are a higher risk for lenders, so they often have stricter requirements. You may need a better credit score, higher income or higher cash reserves. You may also end up with a higher interest rate than you would get with a conforming loan.

Loan Estimate

Your Loan Estimate is a document you receive after you apply for a loan – generally within 3 business days of applying. It contains information on the loan term and estimates on the interest rate, monthly payment amount and closing costs. Because the loan isn’t finalized, these numbers are just an estimate. You’ll receive the final numbers on your Closing Disclosure, which you’ll receive 3 business days before your closing appointment.

Loan Term

Your loan term is the amount of time you have to pay off your loan. The loan term also affects the amount you’ll pay monthly. A shorter term will have higher monthly payments, while a longer loan term will result in lower monthly payments because you’re taking more time to pay off the loan. While the most common loan term is 30 years, 15-year loans are also common.

Mortgage Lender

A mortgage lender offers loans to borrowers to buy real estate. Lenders are also called mortgagees, as they are the ones offering mortgages. The lender sets the interest rates and underwrites loans according to their guidelines.

Mortgage Loan

A mortgage loan is also called a home loan or just a mortgage. This is a loan used to buy real estate. The borrower receives enough money to cover the cost of the home purchase, and the home itself is collateral for the mortgage lender. If the borrower stops making payments, the lender can foreclose on the house.

Mortgage Points

Mortgage points, also known as discount points, are a prepayment to reduce the interest rate of your loan. Each point is worth 1% of the total loan amount and reduces your interest rate by a certain amount. So, while you’ll pay more upfront for mortgage points, you can end up saving a lot more in interest over the life of the loan.

Mortgage Preapproval

Mortgage preapproval is a process in which a lender determines whether you’re likely to qualify for a mortgage, the amount you are likely to qualify for and the interest rate you’re likely to qualify for.

Preapproval isn’t the same as approval since you haven’t gone through the underwriting process. It is possible to be preapproved for a mortgage but then not ultimately approved. However, preapproval can be a good indication of whether your application will ultimately be approved.

Because it requires a detailed credit check, preapproval will impact your credit score. However, this impact is usually relatively minor and temporary.

Private Mortgage Insurance (PMI)

Private mortgage insurance, or PMI, is an extra payment you’ll make on a conventional loan each month if your down payment is less than 20%. This insurance protects your lender if you stop making payments since buyers who put down smaller down payments are considered more of a risk to lenders.

Once you reach 20% equity in your home, you can contact your lender to cancel your PMI. Once you reach 22% equity, your PMI is usually automatically canceled.

Property Taxes

Property taxes are taxes paid by the owners of a property to the local city, county and state governments. They’re calculated based on many factors, but the primary factors are the home’s fair market value and the local property tax rate.

You’ll pay your property taxes once or twice per year, and many lenders will pay them for you out of your escrow account, so you don’t have to do so yourself.

Real Estate Agent

A real estate agent is a professional who oversees a real estate transaction between a buyer and a seller. While a real estate agent can represent both buyers and sellers, they most likely won’t represent both parties for the same transaction. The real estate agent that represents the seller is also called the listing agent.

A real estate agent is paid by commission from the sale of the house. So, if you’re the seller, a percent of the home’s sale price will go to both your agent and the buyer’s agent.

Refinance

Mortgage refinancing is when you replace your old mortgage with a new one. Homeowners may refinance their mortgages for a variety of reasons, including to shorten or lengthen the loan term, lower the interest rate, take cash out of a home’s equity or change a loan from an ARM to a fixed-rate loan.

Seller Concessions

Seller concessions are often offered by home sellers to make the home more affordable to a buyer and help the two come to a sale agreement. When a seller offers concessions, they typically offer to cover certain expenses for the buyer. Seller concessions can include a portion of closing costs. They can also apply to certain repair costs, title insurance, fees and more.

You can try to negotiate seller concessions when you make an offer on a home. But keep in mind that sellers are more likely to offer concessions during a buyer’s market. If you’re buying a home during a seller’s market, you may struggle to get seller concessions.

Title

Your property title represents your legal right to your home. A title isn’t a physical document but rather a concept that establishes the various rights you have to your home. The rights granted to you by your house title include possession, control, exclusion, enjoyment and disposition.

A house title is often confused with a property deed. The deed is the physical document that shows the transfer of a property’s ownership from a seller to a buyer.

Underwriting

Underwriting is the process of confirming all of your financial details and securing the funding for your mortgage. The mortgage underwriter reviews your credit, income, assets and the home’s appraisal to ensure you qualify and can safely make your mortgage payments.

USDA Loan

A USDA loan is a mortgage that’s backed by the U.S. Department of Agriculture. This type of loan makes it easier for low- to moderate-income families to buy homes.

USDA loans can only be homes to purchase a home in a rural area. You must have an income that’s no more than 115% of the median household income. Unlike other loans, USDA loans don’t require down payments, nor will you have to pay mortgage insurance.

VA Loan

A VA loan is a mortgage that’s backed by the U.S. Department of Veterans Affairs. VA loans are only available to eligible military service members and veterans. They provide 100% funding, meaning borrowers aren’t required to have a down payment. VA loans also have competitive interest rates and don’t require mortgage insurance.

A VA loan is a lifetime benefit, meaning veterans and service members can buy multiple homes using one. Buyers are required to pay a funding fee, which varies based on the size of their down payment and whether they’ve used the VA home loan benefit before.

Mortgage Glossary: FAQs

Do you have questions about other popular mortgage terms? Here are some of the most frequently asked questions regarding common mortgage jargon.

What’s the difference between a home inspection and a home appraisal?

A home inspection assesses the condition of a property and looks for necessary repairs. Meanwhile, a home appraisal is a professional assessment of the value of the home. The home inspection helps protect the buyer, while the appraisal is required by a lender to protect their investment. Both are usually necessary parts of the mortgage process.

What’s the difference between a home warranty and home insurance?

A home warranty protects certain appliances and systems within your home, including your kitchen appliances, washer and dryer, HVAC system, and more. It can pay for repairs and replacements in case covered items unexpectedly break down. Your home insurance, on the other hand, protects your home in cases of unexpected hazards like fire, crime and inclement weather. Home insurance doesn't pay for repairs or replacements that aren’t a result of a covered hazard.

What’s the difference between a real estate agent and a REALTOR^®?

A real estate agent operates under a real estate broker to close home transactions. A REALTOR^® is a real estate agent or broker who belongs to the National Association of REALTORS®. They’re bound by a code of ethics and must be experts in their field.

What’s the difference between an interest rate and an annual percentage rate?

An interest rate is the percent of interest charged to borrow the principal amount of your loan, while the APR includes all the associated fees and costs, as well as the interest rate. So, the APR includes the interest rate, but the interest rate doesn’t include the APR. APR represents the true annual cost of borrowing the money.

The Bottom Line

Understanding the common mortgage terms can better prepare you for the home buying process. If you’re ready to buy a home, start the approval process today with Rocket Mortgage^®.