Key Mortgage Terms and What They Mean
Understanding key mortgage terms and what they mean is essential when comparing home loans. To help, here are some of the most common mortgage terms you’re likely to encounter as you shop for a mortgage.
Common Mortgage Terms:
Adjustable Rate Mortgage (ARM)
An adjustable-rate mortgage (ARM) is a type of loan for which the interest rate can change, usually in relation to an index interest rate. Your monthly payment will go up or down depending on the loan’s introductory period, rate caps, and the index interest rate. With an ARM, the interest rate and monthly payment may start out lower than for a fixed-rate mortgage, but both the interest rate and monthly payment can increase substantially.
Amortization means paying off a loan with regular payments over time, so that the amount you owe decreases with each payment. Most home loans amortize, but some mortgage loans do not fully amortize, meaning that you would still owe money after making all your payments.
Some home loans allow payments that cover only the amount of interest due, or an amount less than the interest due. If payments are less than the amount of interest due each month, the mortgage balance will grow rather than decrease. This is called negative amortization.
Other loan programs that do not amortize fully during the loan may require a large, lump sum “balloon” payment at the end of the loan term. Be sure you know what type of loan you are getting.
Annual Percentage Rate (APR)
An annual percentage rate (APR) is a broader measure of the cost of borrowing money than the interest rate. The APR reflects the interest rate, any points, mortgage broker fees, and other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate.
An appraisal fee is the cost of a home appraisal of a house you plan to buy or already own. Home appraisals provide an independent assessment of the value of the property. In most cases, the selection of the appraiser and any associated costs is up to your lender.
Closing costs are processing fees you pay to your lender. Lenders charge these fees in exchange for creating your loan. Closing costs cover things like your home appraisal and searches on your home’s title. The specific closing costs you’ll need to pay depend on the type of loan you take and where you live.
A Closing Disclosure is a required five-page form that provides final details about the mortgage loan you have selected. It includes the loan terms, your projected monthly payments, and how much you will pay in fees and other costs to get your mortgage.
A conventional loan is any mortgage loan that is not insured or guaranteed by the government (such as under Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture loan programs).
A credit score predicts how likely you are to pay back a loan on time. Companies use a mathematical formula—called a scoring model—to create your credit score from the information in your credit report. There are different scoring models, so you do not have just one credit score. Your scores depend on your credit history, the type of loan product, and even the day when it was calculated.
Your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income. This number is one-way lenders measure your ability to manage the monthly payments to repay the money you plan to borrow.
The Closing Disclosure has a statement that reads “Your loan has a demand feature,” which is checked “yes” or “no.” A demand feature permits the lender to require early repayment of the loan.
A down payment is the amount you pay toward the home upfront. You put a percentage of the home’s value down and borrow the rest through your mortgage loan. Generally, the larger the down payment you make, the lower the interest rate you will receive and the more likely you are to be approved for a loan.
Earnest money is a deposit a buyer pays to show good faith on a signed contract agreement to buy a home. The deposit is held by a seller or third party like a real estate agent or title company. If the home sale is finalized or “closed” the earnest money may be applied to closing costs or the down payment. If the contract is terminated for a permissible reason, the earnest money is returned to the buyer. If the buyer does not perform in good faith, the earnest money may be forfeited and paid out to the seller.
Equity is the amount your property is currently worth minus the amount of any existing mortgage on your property.
An escrow account is set up by your mortgage lender to pay certain property-related expenses, like property taxes and homeowner’s insurance. A portion of your monthly payment goes into the account. If your mortgage doesn’t have an escrow account, you pay the property-related expenses directly.
The Federal National Mortgage Association (Fannie Mae) purchases and guarantees mortgages from lending institutions in an effort to increase affordable lending. Fannie Mae is not a federal agency. It is a government-sponsored enterprise under the conservatorship of the Federal Housing Finance Agency (FHFA).
FHA funding fee
The Federal Housing Administration (FHA) requires an FHA funding fee and a monthly insurance premium (MIP) for most of its single-family programs. This upfront mortgage insurance premium is sometimes called an upfront mortgage insurance premium (UFMIP).
FHA loans are loans from private lenders that are regulated and insured by the Federal Housing Administration (FHA). They differ from conventional loans because they allow for lower credit scores and down payments as low as 3.5 percent of the total loan amount. Maximum loan amounts vary by county.
A finance charge is the total amount of interest and loan charges you would pay over the entire life of the mortgage loan.
First-time home buyers (FTHB) loan programs
First-time home buyers (FTHB) may use a few different types of loan programs to purchase their first home. Popular FTHB loans include programs offered by FHA, VA, USDA, Fannie Mae, and Freddie Mac with low down payments. Some programs define a FTHB as someone who hasn’t purchased a home in three years or more.
A fixed-rate mortgage is a type of home loan for which the interest rate is set when you take out the loan and it will not change during the term of the loan.
Foreclosure is when the lender or servicer takes back property after the homeowner fails to make mortgage payments. In some states, the lender must go to court to foreclose on your property (judicial foreclosure), but other states do not require a court process (non-judicial foreclosure). Generally, borrowers must be notified if the lender or servicer begins foreclosure proceedings. Federal rules may apply to when the foreclosure may start.
The Federal Home Loan Mortgage Corporation (Freddie Mac) is a private corporation founded by Congress. Its mission is to promote stability and affordability in the housing market by purchasing mortgages from banks and other loan makers. The corporation is currently under conservatorship, under the direction of the Federal Housing Finance Agency (FHFA).
Government recording charges
Government recording charges are fees assessed by state and local government agencies for legally recording your deed, mortgage and documents related to your home loan.
HOA – Home Owners Association Dues
If you’re interested in buying a condo, co-op, or a home in a planned subdivision or other organized community with shared services, you usually have to pay condo fees or Homeowners’ Association (HOA) dues. These fees vary widely. Condo or HOA fees are usually paid separately from your monthly mortgage payment. If you do not pay these fees, you can face debt collection efforts by the homeowner’s association and even foreclosure.
An appraisal is a written document that shows an opinion of how much a property is worth. The appraisal gives you useful information about the property. It describes what makes it valuable and may show how it compares to other properties in the neighborhood. An appraisal is an independent assessment of the value of the property.
The purpose of a home inspection is to find problems with the house’s structure. A home inspector will test key appliances, assess the heating and air-conditioning system, inspect the plumbing and electrical infrastructure, and maybe look into the attic and basement. In addition, the house inspector will search for signs of bug, water, or fire damage, as well as any other problem that might depreciate the property’s value.
The index is a benchmark interest rate that reflects general market conditions. The index changes based on the market. Changes in the index, along with your loan’s margin, determine the changes to the interest rate for an adjustable-rate mortgage loan.
An interest rate on a mortgage loan is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan. For example, if the mortgage loan is for $100,000 at an interest rate of 4 percent, that consumer has agreed to pay $4,000 each year he or she borrows or owes that full amount.
A jumbo loan, or jumbo mortgage, is a home loan for an amount that exceeds the “conforming loan limit” set on mortgages eligible for purchase by Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that ultimately buy and administer most single-family-home mortgages in the U.S.
The loan-to-value (LTV) ratio is a measure comparing the amount of your mortgage with the appraised value of the property. The higher your down payment, the lower your LTV ratio. Mortgage lenders may use the LTV in deciding whether to lend to you and to determine if they will require private mortgage insurance.
The margin is the number of percentage points added to the index by the mortgage lender to set your interest rate on an adjustable-rate mortgage (ARM) after the initial rate period ends. The loans margin is set in your loan agreement and won’t change after closing. The margin amount depends on the lender and loan.
This is how much you spend every month. It can include, but is not limited to, recurring obligations like rent or mortgage payment, utilities, car payments, child support payments, and insurance payments, as well as essentials like food. Most of these obligations will have a fixed due date.
A mortgage is an agreement between you and a lender that allows you to borrow money to purchase or refinance a home and gives the lender the right to take your property if you fail to repay the money you’ve borrowed.
Mortgage insurance (MI) protects the lender if you fall behind on your payments. MI is typically required if your down payment is less than 20 percent of the property value. Mortgage insurance also is typically required on FHA and USDA loans. However, if you have a conventional loan and your down payment is less than 20 percent, you will most likely have private mortgage insurance (PMI). You may also request to cancel the PMI once sufficient equity is obtained.
Mortgage refinance is when you take out a new loan to pay off and replace your old loan. Common reasons to refinance are to lower the monthly interest rate, lower the mortgage payment, or to borrow additional money. When you refinance, you usually have to pay closing costs and fees. If you refinance and get a lower monthly payment, make sure you understand how much of the reduction is from a lower interest rate and how much is because your loan term is longer.
The term of your mortgage loan is how long you must repay the loan. For most types of homes, mortgage terms are typically 15-year, 20- or 30-years.
Origination Fee or Points
An origination fee is what the lender charges the borrower for making the mortgage loan. The origination fee may include processing the application, underwriting and funding the loan, and other administrative services. Origination fees generally can only increase under certain circumstances.
The principal is the amount of a mortgage loan that you must pay back. Your monthly payment includes a portion of that principal. When a payment on the principal is made, the borrower owes less, and will pay less interest based upon a lower loan size.
Property taxes are taxes charged by local jurisdictions, typically at the county level, based upon the value of the property being taxed. Often, property taxes are collected within the homeowner’s monthly mortgage payment, and then paid to the relevant jurisdiction one or more times each year. This is called an escrow account. If the loan does not have an escrow account, then the homeowner will pay the property taxes directly.
A Qualified Mortgage is a category of loans that has certain, more stable features that help make it more likely that you’ll be able to afford your loan.
Recast a mortgage
Occasionally, homeowners will receive cash from a bonus, a tax return refund, a relative’s financial gift, or the sale of a previous home after closing. You may consider making a sizeable payment to your mortgage balance. A mortgage recast allows you to lower your mortgage balance and monthly payment without having to refinance.
A reverse mortgage allows homeowners age 62 or older to borrow against their home equity. It is called a “reverse” mortgage because, instead of making payments to the lender, you receive money from the lender. The money you receive, and the interest charged on the loan, increases the balance of your loan each month. Most reverse mortgages today are called HECMs, short for Home Equity Conversion Mortgage.
A second mortgage or junior lien is a loan you take out using your house as collateral while you still have another loan secured by your house.
When lenders use the term, they generally mean a loan program for borrowers who do not qualify for a prime loan, often with a higher interest rate.
The Rural Housing or Rural Development, is part of the U.S. Department of Agriculture (USDA) offers mortgage programs with no down payment and generally favorable interest rates to rural homebuyers who meet the USDA’s income eligibility requirements. Learn more about this and other special loan programs.
A VA loan is a loan program offered by the Department of Veterans Affairs (VA) to help servicemembers, veterans, and eligible surviving spouses buy homes.
The VA does not make the loans but sets the rules for who may qualify and the mortgage terms. The VA guarantees a portion of the loan to reduce the risk of loss to the lender. The loans generally are only available for a primary residence.
If you’re a veteran, find out if a VA loan is the right fit for you.