Mortgage Terms
Explanation of Mortgage Terms
Mortgage terminology can be confusing and overly complicated—but it doesn’t have to be! We’ve broken down some of the terms to help make them easier to understand.
Home Price
Across the country, average home prices have been going up. Despite the rise in home prices, you can still find a perfect home that’s within your budget!
As you begin to house hunt, just make sure to consider the most important question:
How much house can I afford? After all, you want your home to be a blessing, not a burden.
Down Payment
The initial cash payment is usually represented as a percentage of the total purchase price, a home buyer makes when purchasing a home. For example, a 20% down payment on a $200,000 house is $40,000. A 20% down payment typically allows you to avoid private mortgage insurance (PMI). The higher your down payment, the less interest you pay over the life of your home loan. The best way to pay for a home is with a 100% down payment in cash! Not only does it set you up for building wealth, but it also streamlines the real estate process.
Mortgage Types
15-Year Fixed-Rate Mortgage
A home loan designed to be paid over a term of 15 years. The interest rate remains the same for the life of the loan. A 15-year mortgage will have a higher monthly payment but a lower interest rate than a 30-year mortgage. Because you pay more toward the principal amount each month, you’ll build equity in your home faster, be out of debt sooner, and save thousands of dollars in interest payments.
30-Year Fixed-Rate Mortgage
A home loan designed to be paid over a term of 30 years. The interest rate remains the same for the life of the loan. A 30-year mortgage will have the lowest monthly payment amount but usually carries the highest interest rate—which means you’ll pay much more over the life of the loan. Unless you like the idea of paying thousands of dollars more for your home than you have to and staying in debt twice as long as you need to, opt for a 15-year mortgage if you’re not paying cash for your home.
5/1 Adjustable-Rate Mortgage (ARM)
A home loan designed to be paid over a term of 30 years. The interest rate does not change for the first five years of the loan. After that time period, however, it adjusts annually based on market trends until the loan is paid off. The interest rates are usually comparable to a 30-year mortgage, but ARMs transfer the risk of rising interest rates to you—the homeowner. The initial interest rate on an ARM is typically lower than that of a fixed-rate mortgage, making it an attractive option for borrowers who want to keep their initial payments low, or who expect their income to increase in the future. However, once the initial fixed period ends, the interest rate on the ARM can adjust up or down depending on the movement of the benchmark index!
Interest Rate
The ongoing cost of financing a home purchase. This is generally shown as an annual percentage of the outstanding loan. For example, a 5% interest rate on a $200,000 mortgage balance would add $833 to the monthly payment. As the balance is paid down through monthly payments, the interest portion of your payment is reduced.
Private Mortgage Insurance (PMI)
Calculated annually as a percentage of your original mortgage amount based on your credit rating and down payment. PMI protects the lender in the event you do not pay your mortgage, and it generally costs 0.5% of your loan each month. The additional cost does not apply toward your mortgage payoff. In most cases, you can avoid PMI if you put 20% down on your home purchase.
Homeowner’s Insurance
Generally a requirement for any home mortgage. The premium is usually included with the monthly mortgage payment. Costs and coverage vary by state and the value of the home. Get professional advice to make sure you have the proper coverage. Homeowner’s insurance can cover the cost to repair or rebuild due to damage caused by events like fire, windstorms, hail, lightning, theft, or vandalism. It can also protect your possessions inside your home like clothes, furniture, and electronics.
Homeowner’s Association (HOA) Fees
Fees are due in exchange for being part of a homeowner’s association. A homeowner’s association is an organization in a planned community that maintains and reinforces rules for the properties in its jurisdiction. By purchasing a property in such a community, the homeowner is agreeing to the HOA’s rules and fees. HOAs maintain a significant amount of legal power over property owners regarding the outside conditions of the home.
Monthly Payment
The amount you pay each month for your mortgage, homeowner’s insurance, and HOA fees. This payment should be no more than 25% of your monthly take-home pay. That leaves plenty of room in your budget to achieve other goals, like saving for retirement or putting money aside for your kid’s college fund.
Property Taxes
Taxes you have to pay based on the government’s appraisal of your property. These are usually included as part of your monthly mortgage payment. Property taxes vary greatly depending on location and home price.
Pre-Qualification
When you prequalify for a home loan, you are getting an estimate of what you might be able to borrow based on a credit check and information you provide about your finances. This is an early step in your home-buying journey and gives you the opportunity to learn about different mortgage options and work with your lender to identify the right fit for your needs and goals.
Pre-Approval
When you get pre-approved for a home loan you will complete a full mortgage application, and credit check, and the lender will verify the information you provide. A Preapproval is as close as you can get to confirming your creditworthiness without having a purchase sales contract in place. If you are preapproved you will receive a pre-approval letter to lend you a specific amount, this is good for 90 days.
