Mortgage and Loan Terminology: The Basics
The world of loans mortgages can be overwhelming, full of big financial decisions and unfamiliar terminology. But with a little help from a reputable bank and loan officer – and practical knowledge about mortgage and loan related words, phrases, and acronyms – you’ll be well on your way to success:
Amortization is paying off a loan over time in installments. Over time, more of your payment will go toward principal rather than interest.
APR refers to Annual Percentage Rate, or the cost of borrowing money. APR reflects the true cost of a loan, since in addition to the interest rate it includes factors like discount points and other expenses.
Closing Costs are the upfront fees borrowers must pay at the time of loan signing, including origination fee, appraisal fee, credit report fee, title search fee, and more.
Debt-to-Income Ratio (DTI) gauges ability to repay a loan, and is calculated by dividing the borrower’s total monthly debt payments by total monthly gross income.
Discount Points allow buyers to purchase a lower interest rate. A general guideline is that one point costs 1% of the loan and lowers the interest rate by .25%. This strategy only makes sense if a homeowner will keep the house long enough to come out ahead on the initial expense.
Down Payment means the amount of money a borrower pays up front for a home, while financing the rest with a mortgage. Different kinds of mortgages have different requirements for minimum down payment.
Earnest Money is a deposit that a home buyer puts down on a property as a show of good faith that they intend to purchase. This money is generally held by the escrow company and applied to the down payment, or is sometimes refunded if the deal falls through due to circumstances permitted in the purchase agreement.
Escrow is usually set up by a mortgage lender. Through an escrow account, a portion of the monthly mortgage payment is diverted and held, and these funds are eventually used to cover homeowner’s insurance and property taxes. This system ensures that these important bills are paid.
Loan-to-Value Ratio (LTV) compares the value of the mortgage loan to the value of the property. An ideal ratio is no more than 80% — which translates to a 20% down payment.
PITI stands for principal, interest, taxes, and insurance. These four items are all included in a monthly mortgage payment – the first two are owed to the mortgage company, while the second two are put aside by the mortgage company (in escrow) to be paid out as bills come due.
Preapproval comes from a bank or mortgage company. After a credit check and some basic financial research, the lender will issue a letter stating what size mortgage they might issue. While it isn’t a guarantee of a loan, it is a useful tool to show a seller.
Private Mortgage Insurance (PMI) is required when a buyer puts down less than 20% as a down payment. This protects the lender in the event that the borrower defaults. Through paying down the mortgage, increase in the property’s value, or both, this expense may be eliminated as time passes.
Underwriting is how a bank or mortgage lender assesses the risk of lending to a particular borrower. Credit report, credit score, income, debt, and property value are all considered in determining whether to approve a loan.