When you’re buying your own home, you had better go into it with an understanding of all the terms used in the mortgage business so that you really know what you’re getting into. Knowledge is power, and this is especially true when talking about large purchases like buying a house.
Getting a new house is exciting and life-affirming; securing a mortgage to finance that can be complex and time-consuming. Reading this quick and easy guide to the 10 most used terms in mortgages will smoothen the experience and help you get the best deal possible.
Adjustable Rate Mortgage (ARM)
An ARM loan, also known as a variable-rate mortgage or a tracker mortgage, has an initial interest rate that is usually lower than most fixed rate mortgages. You get this rate locked in for a year or more. But once the predetermined initial term is over, the interest rate is at the mercy of the housing market. The rate will go up or down during whatever preselected intervals the lender chooses, throughout the loan. Rates and monthly payments can go up sharply. This loan is suitable for people only planning to live in a house for 2 to 3 years, or however long the initial low interest rate term is, and then plan on selling, therefore covering the mortgage fully.
Annual Percentage Rate (APR)
The Annual Percentage Rate for your home loan is a yearly calculation of the interest rate the mortgage company quoted, plus home loan costs such as origination fees and points. Remember that your loan’s APR will be higher than your quoted interest rate, because of additional fees and costs.
The buying and selling of real estate has many moving parts. And each of those parts need to be paid for. Agencies need to be paid fees for their work, and expenses need to be compensated. These fees are usually shared by the buyer and seller, and they are collectively called closing costs. Closing costs include: loan origination fees, escrow payments, title insurance, attorney fees and possibly discount points paid to lower the loan’s interest rate.
Escrow is a neutral third party who holds your documents and money during the loan process, including earnest money deposits, until the entire transaction is completed. An escrow account is also used to hold the property tax and insurance money that is collected with each mortgage payment.
In a fixed-rate mortgage, the interest rate stays the same throughout the life of the loan. The payment plans are usually spread out over a period of 10, 15, 20 or 30 years and are covered with monthly payments. It’s secure and reliable, not at the mercy of the housing market, and you can reliably predict the size of your monthly payments if you take one. If you plan to live long-term in your house, this is the most highly recommended type of mortgage.
Loan to Value Ratio (LVR)
The LVR is the ratio of the your loan amount as compared to the value of the property the loan is meant to purchase. So if you have an $80,000 mortgage on a $100,000 dollar house you have an 80% LVR. The rest of the money, $20,000, is paid as a down payment. An LVR of more than 80% of the house price requires you to purchase private mortgage insurance (PMI). For example, if you want to take a $90,000 mortgage on a $100,000, which means your LVR is 90%, you need PMI. Basically, you need to pay at least 20% down payment for your house to negate the need for mortgage insurance.
Home mortgage interest rates fluctuate daily. While you are trying to find a loan that works for you, you may decide to ‘lock-in’ a specific interest rate with the lender you are trying to procure a loan from. A “locked-in” interest rate means your entire loan will be processed with this rate, even if interest rates go up (or down) before your loan closes.
Two kinds of points are involved with a home mortgage. One point equals 1% of the loan amount. Discount points reduce the loan’s interest rate. Origination points can be added to cover the costs that arise while processing a loan. So if you want to lower your interest rate by one point on a $200,000 mortgage, you will need to pay $2,000 more down payment at closing. Essentially these are loan adjustments that can help if you want to change a few things.
Private Mortgage Insurance (PMI)
If you want to have a loan that is worth more than 80 percent of the house price, the lender will need you to buy PMI. Because this is a risk for them, they need to have some insurance that if you default on the loan, the lender won’t have to eat a huge loss. You will receive monthly PMI payment requests along with your mortgage payment requests. Remember, if you have paid off 20 percent of your housing costs, or built 20% equity, you should look into cancelling your PMI and lowering your monthly mortgage payments overall.
This is a requirement for all house mortgages, protecting both the buyer and the seller. This policy ensures that the property owner has the right to transfer a home’s title to the seller. If there is a problem in this transaction, the title company pays the legal fees to correct whatever anomalies exist and make the deal go through.
You should back yourself up with as much information as possible when buying real estate. By understanding these terms and doing additional research as needed, you’ll be an informed consumer when you get your mortgage – and informed consumers get the very best deals.
Featured Image: Thinkstock/BernardaSvPosted on May 18, 2023