As you go through the process of getting a mortgage so you can purchase your dream home, you may feel like your mortgage broker and lender are speaking a different language. As they toss acronyms such as ARM and APR about and carry on discussions about balloons, it’s understandable that you may not pick up on what they’re trying to tell you. Here’s a list of some of the most common mortgage terms to help you keep up with the conversation so you know what’s going on with your mortgage every step of the way.
What is Amortization?
Mortgage payments are calculated using amortization. AÂ portion of your mortgage payment goes toward the principal or loan balance, and the remainder goes toward interest. Each month as you make payments, you reduce the amount of principal owed. The lender recalculates the payment based on the current loan balance each time, so that even though your payment remains the same, a different amount goes toward principal and interest. During the early years of a mortgage, the majority of your payment goes toward interest. By the end, a greater percentage goes toward principal.
What Is a Fixed-Rate Mortgage?
A fixed-rate mortgage is the most common type of conventional mortgage. Whether your mortgage term is for 15 or 30 years, the interest rate will not change over the life of the loan. This means that your monthly payments will not change, either. A fixed-rate mortgage protects you from any increase in the federal interest rate during the life of your loan, but it also prevents you from taking advantage of lower interest rates unless you opt to refinance the loan.
What is an Adjustable-Rate Mortgage (ARM)?
With an adjustable-rate mortgage, you are subject to changes in the federal interest rate over the life of your loan. If the rate increases or decreases, your mortgage rate and therefore your monthly payments will change. Most adjustable-rate mortgages are protected from interest rate changes during the first year, and changes may only be made by your lender on a specific interval, usually once or twice per year. They generally also have a cap in how high the interest rate can go to protect you from huge swings in payments.
What is an Assumable Mortgage?
Some mortgages are assumable, which means that the original mortgage holder can let a buyer who has good credit take over his mortgage loan and payments. This works well for buyers in most cases as they can save money on closing costs for a new mortgage, but it may not be a good decision if the note’s interest rates are higher than the current rate. Note that some mortgages do not address whether they’re assumable or not, but they do have a “due on sale” clause which means that the mortgage balance is due when the property is sold. In the end, that type of mortgage loan is not assumable.
What is a Debt-to-Income Ratio (DTI)?
A debt-to-income ratio is one piece of criteria that lenders look at to determine whether you’re a good risk for the mortgage you’re applying for. To calculate your DTI, add your monthly housing expense to your monthly recurring debts, and then divide the result by your gross monthly income. Your housing expense includes your mortgage payment, taxes and insurance, while recurring debt includes credit card payments, child support or alimony, loan payments, and insurance.
What is Loan to Value (LTV)?
This is another piece of criteria lenders use as they complete a risk assessment. To calculate a loan-to-value ratio, take the mortgage principal balance you are applying for and divide that by either the purchase price of the property or its appraised price, whichever is lower. If your LTV isn’t at least 80 percent, you may be subject to private mortgage insurance, higher interest rates or points due on the loan.
What does PITI mean?
PITI is a simple acronym that lenders use to describe your mortgage payment. If you hear the term used, then it means that the lender plans on rolling up your principal and interest payments each month with your property tax payments and homeowner’s insurance. PITI = Principal + Interest + Taxes + Insurance.
What is Private Mortgage Insurance (PMI)?
Borrowers who do not have a down payment of at least 20 percent may be subject to private mortgage insurance until their equity reaches that magic number. PMI protects the lender in case you default on your loan. Keep in mind that it does not protect you, and the lender may still foreclose on your home if you default on the loan.
What are Points?
A point, which is the equivalent of one percent of your mortgage principal, is money paid up-front at the closing. Points may be assessed by the lender to cover the cost of originating the loan, or the borrowers may choose to pay discount points up-front to reduce the mortgage’s interest rate.
What Does Escrow Mean?
An escrow is an agreement made between two parties that money, contracts or anything else of value be held by a neutral third party pending some action in the future. Any monies paid toward your down payment are held in escrow until the closing. Lenders who roll your tax and insurance money into your monthly mortgage payments hold that money in escrow until the taxes and insurance premiums are due.
What is an Acceleration Clause?
An acceleration clause lets your mortgage lender immediately demand repayment of your entire mortgage balance if you violate any stipulations set forth in the mortgage contract. Depending on how your contract is written, the lender may invoke the acceleration clause for failure to make a mortgage payment on time, making late property tax payments that results in a tax lien on the property or canceling your homeowner’s insurance.
2 Point Highlight
A fixed-rate mortgage is the most common type of conventional mortgage.
Some mortgages are assumable, which means that the original mortgage holder can let a buyer who has good credit take over his mortgage loan and payments.
