Applying for a mortgage can feel confusing, especially if you aren’t familiar with all of the jargon your loan professional uses. Words like “amortization” or acronyms like “ARM” might sound complex, but they are fairly simple, once you get to know them. Grab some notecards and a pen (or bookmark this page) because we are going to help you learn lending lingo.
Adjustable-Rate Mortgage (ARM)
Interested in a loan with flexibility? An ARM might be a good fit. An adjustable-rate mortgage (ARM) is a loan with an interest rate that varies over time depending on how market rates move. Borrowers can get an ARM with a short period of fixed interest. Once the fixed period has passed, the interest rate will get larger or smaller depending on market interest rates.
In simple terms, an amortization is how loan payments are spread out over time. Think of it as a payment plan. Part of each payment goes toward principal, and the other part to interest.
At the beginning of an amortization plan, the borrower pays more toward interest than they do to principal. As the life of the loan progresses, the borrower will pay less toward interest and more toward the loan balance.
Annual Percentage Rate (APR)
You know how every square is a rectangle, but not every rectangle is a square? Well, the same goes for annual percentage rates. While the annual percentage rate (APR) includes the interest rate, the interest rate does not include the APR.
An APR reflects the interest rate a borrower will pay on a loan annually, as well as any additional lender fees. A borrower’s APR will reflect interest rate, discount points, and additional fees and charges. Borrowers can compare APRs across loan types and lenders.
The costs and fees you pay to a lender for originating, underwriting, and closing your mortgage are called closing costs. While they vary based on the lender and mortgage, closing costs typically range from 3% to 6% of the purchase price of the home.
Closing costs can include appraisal fees, origination fees, title insurance, and credit report fees. Depending on how the purchasing negotiations go between the parties, either the buyer or seller can pay the closing costs.
Debt-To-Income (DTI) Ratio
A debt-to-income (DTI) ratio is the sum of a borrower’s recurring monthly debts divided by the total gross monthly household income. Most lenders look for a DTI ratio of 50% or lower. To find your DTI ratio, use this equation:
DTI ratio % = (Total Monthly Debt ÷ Total Monthly Income) x 100
Discount points are an optional closing cost where a borrower can pay to “buy” a lower interest rate. Normally, one discount point is equal to 1% of the loan amount.
How do discount points work? Essentially, discount points allow you to pay more upfront in exchange for a lower interest rate, which means you will pay less over the life of the mortgage.
The down payment is the first payment on a mortgage loan made by the borrower which is usually a percentage of the loan value. So, if a borrower is approved for a $100,000 loan, they would pay a $20,000 down payment at closing.
To make homebuying more feasible, government-backed loans allow borrowers to buy a home with little to no down payment. These include FHA, USDA, and VA loans. But more about those later.
Escrow is an account where a lender holds money for a borrower’s property taxes or homeowner’s insurance. Having an escrow account lets a borrower distribute tax and insurance costs over a course of 12 months rather than paying it all at once. Escrow payments may be added to their existing monthly mortgage costs.
When a borrower has a fixed-rate mortgage it means that the mortgage has the same interest rate throughout the life of the loan. This means that, even if market rates fluctuate lower and higher, the borrower’s interest will remain unchanged. It’s great when the market rate is above their existing rate, however if the market rate is lower, the borrower is locked in at a higher rate than what they could be paying.
A mortgage term is the number of years you pay on a loan before you fully own the home. It is also known as the “life of the loan.” So, if a borrower has a 15-year term on their mortgage, they will pay down the loan for 15 years. The most common mortgage terms are 15 and 30 years.
A preapproval is a document telling you how much a borrower can afford. This is not to be confused with a prequalification, which we will get to later. A preapproval is a good first step in the mortgage process because it can help borrowers focus on homes in their budget and will make the loan application process move quicker.
A prequalification gives you a rough idea of how much money you might be able to borrow for a home loan. This number is based on a review of your income, credit and debt information however, it is not set in stone.
Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is what protects your lender in the event you default on your loan. It is usually required if you have less than 20% for a down payment. Some lenders may give you the option to drop your PMI policy once you have 20% equity in the home.
A refinance allows a borrower to trade the original debt obligation of their existing mortgage for a new debt arrangement. Refinances can be used to take advantage of a lower interest rate or to have a more flexible payment plan, among other options.
1All loans subject to credit approval and identification of acceptable property. Conditions and restrictions may apply.
2All loans subject to credit approval. A prequalification is not an approval of credit and does not signify that underwriting requirements have been met. Conditions and restrictions may apply.