Defining 26 Important Mortgage Terms You Must Understand

Understanding the home buying process is a complicated feat for first-time homebuyers. Between managing all the moving pieces, to number crunching - you are bound to get overwhelmed.

If there is anything you should prepare for, it is getting bombarded with a hailstorm of new words that you do not understand.

The professionals working with you should help clarify these common terms for you. If they do not, and you feel lost - you should consider hiring another mortgage advisor. Alternatively, you can read this article!

This article will go through some of the most important and commonly used vocabulary in the industry. If you want to understand the home-buying process, you should be prepared to get comfortable with these words.

Defining Important Mortgage Terms

Adjustable-Rate Mortgage (ARM)

This is a type of mortgage where the interest rate is subject to change (or adjust) throughout the life of the loan based on the market’s interest rates. After a certain period of time, the interest rates reset periodically, this can be at yearly or monthly intervals. For example, in a 7/1 ARM, the borrower’s rate will remain fixed for 7 years, after that time period, the rate will adjust. Annual limitations regarding how much an ARM Mortgage may fluctuate are established by the current market interest rates.

Amortization

A loan amortization refers to the time it takes for the borrower to pay off their debt, specifically against their principal and interest. An amortization schedule will detail exactly how much of your monthly payments go toward the principal and interest.

Annual Percentage Rate (APR)

Your APR shows you how much interest you are paying on an annual basis, it is represented as a percentage of your total loan balance. For instance, an APR of 5% means that you are paying $50 of interest for every $1,000 you borrowed.

Appraisal

Before closing on your mortgage, the house you intend to purchase must be inspected. A qualified appraiser will inspect the home for safety, damages, and any improvements needed, to arrive at an estimated value of the property. This written estimate (or opinion) of a property’s value is known as an appraisal.

Construction Mortgage

This is a type of loan that is used to pay for the construction of a new home. It is typically a short-term loan, with payments being made according to the construction schedule of the new home. The final payment should be made when the house gets occupied by the borrower.

Conventional Mortgage

A home loan that is issued by a private company and not backed up by a government sponsor. Due to the high risks associated with these loans, credit standards and down payment requirements are stricter than government-sponsored loans. Underwriting guidelines for these loans should conform with Fannie Mae or Freddie Mac. Unless the borrower makes a down payment of at least 20%, they will need to pay for Private Mortgage Insurance (PMI).

Debt-to-Income Ratio (DTI)

The DTI accounts for the borrower’s monthly debt payments in relation to their gross monthly income. This calculation is used to determine the mortgage amount a borrower qualifies for and is benchmarked at 43% of the gross monthly income.

Discount Points

Also known as mortgage points, these are fees that are paid to the lender at closing to reduce the interest rates on the loan and in turn, will reduce your monthly payment. 1 discount point would equal 1% of the total mortgage amount. This is often referred to as “buying down the loan”.

Escrow

An escrow is a legal arrangement in which a third party (not involved in the transaction) would hold onto an item of value. This item is kept in an escrow account and is to be deposited upon the fulfillment of certain conditions. For instance, after closing on a mortgage, the borrower will deposit a few months' worths of monthly payments to an escrow. Once the payment is due, the holder of the escrow account disburses the payment. It is very common for the title company to be the third-party holder of escrow.

FHA Mortgage

A government-supported loan guaranteed by the Federal Housing Administration (FHA). Due to being sponsored by the government, FHA loan guidelines are typically less strict than conventional.  Borrowers get to make a minimum down payment of 3.5% and can have a low credit score. Albeit, they will have to pay an upfront mortgage insurance premium to balance the risk.

Fixed-Rate Mortgage

A mortgage with an interest rate that does not change during the payback period of the loan.

Fannie Mae (FNMA)

Otherwise known as the Federal National Mortgage Association (FNMA). Fannie Mae is a government-sponsored entity that aims to support the secondary mortgage market. They do so by trading in mortgage contracts to investors, freeing up money for financial institutions to provide more lending.

Freddie Mac (FHLMC)

Otherwise known as the Federal Home Loan Mortgage Corporation (FHLMC). Freddie Mac is a government-sponsored entity that supports the secondary mortgage market. The investor purchases mortgage contracts from lenders on the secondary mortgage market. They then resell these contracts to investors in the open market. This keeps the mortgage industry liquid, by freeing up money for additional lending.

Foreclosure

A foreclosure happens when the borrower defaults and is no longer able to meet their monthly payments. As a result, the lender takes on legal action in an attempt to recover the balance of a loan by forcing the sale of collateral used against the mortgage.

Home Equity Loan

A Home Equity Loan as well as a Home Equity Line of Credit (HELOC), uses your home equity, which is the difference between the value of the home and your mortgage balance, as collateral. Home Equity Loans are often used to finance home improvements and debt repayments and usually offer competitive interest rates.

Jumbo Mortgage

This is a loan that exceeds the “conforming loan limit” set by Freddie Mac and Fannie Mae. Currently, the government-sponsored organizations set a limit of $417,000 for most states in the US and $625,000 in high-cost counties. Due to the lack of government support for these loans and the considerably higher risk, the qualifying guidelines for these loans are more strict (i.e. down payments, credit rating, etc.).

Loan to Value Ratio (LTV)

This ratio compared the total loan amount to the value of the property. Lenders use the LTV ratio to determine the level of risk they take on when underwriting the mortgage. The higher the LTV ratio, the riskier the prospect, since lenders perceive a higher chance that the borrower defaults because there is little equity built up within the loan.

Mortgage Payoff Statement

This is a document provided by the lender, it details precisely how much the borrower needs to pay off the loan. Typically needed when putting the home up for sale. The payoff statement will highlight any remaining principal owed on the loan, plus any interest that was accumulated since the start of the loan up until the pay-off date.

Prequalification

An initial assessment was conducted by the lender over the amount it intends to lend to a potential homebuyer. It is a process that determines how much a borrower would be eligible to borrow before applying for a loan.

Principal, Interest, Taxes, and Insurance (PITI)

Your PITI is the four main components that make up your monthly mortgage payments, excluding any other service fees such as escrow.

Private Mortgage Insurance (PMI)

This is an insurance cost added to the monthly payments of conventional loan borrowers who put less than 20% down as a down payment.

Reverse Mortgage

A mortgage targeted to senior borrowers 62 years of age or older, whereby the equity of the home is converted to cash for use by the homeowner. This money can be used to support their income after retirement. The amount owed on the mortgage does not change and will have to be paid off before the sale of the home.  Borrowers are still responsible for property taxes and homeowner’s insurance.

Short Sale

A short sale occurs when a distraught borrower decides to sell their home for less than their mortgage balance. The lender either forgives the borrower for the remaining amount, or files for a court order to demand that the borrower repays the lender for what is left to pay off (this is known as a deficiency judgment). The lender must approve getting a short sale before the process happens (this is known as a pre-foreclosure sale). The lender will require documentation validating the reasons for the short sale. The process is often lengthy and involves a lot of paperwork as it is a high-risk decision for the lender. As far as your credit health goes, applying for a short sale is far less harmful than getting into a foreclosure.

Underwriting

This is a step in the loan process whereby the lender verifies your income, assets employment, debt, and property details, to determine whether or not you qualify for a mortgage.   

USDA Mortgage

The U.S. Department of Agriculture backed mortgage. These mortgages are limited to houses in certain rural areas and have income limits.

VA Mortgage

A government-backed mortgage guaranteed by the Veterans Administration, targets active US service members, veterans, and their spouses. These mortgages offer less strict lending guidelines and zero down payments for eligible veterans.  

Final Thoughts

As you start to explore buying a home, we hope that understanding and educating yourself on these terms and all your options will help you to better understand the process and to ensure your first homebuying experience is a positive one.

About the Author

Qais Hudhud is a copywriter and technology specialist at Premier Lending. For two years, Qais wrote articles that touched on banking and microfinance institutions. Later graduated into mortgages, where he worked alongside industry experts with over 11 years of experience in helping homeowners from the west coast to the east coast, achieve their dreams.