The home-buying process can often be a confusing one — whether you’ve bought a property before or not. There’s a lot of prep work and moving parts, and most of the terminology is unfamiliar to the average consumer.
Fortunately, that last part is an easy fix!
Are you getting ready to buy a home or refinancing your current one? Take a look at some of the terms involving home-buying that you might want to learn about or brush up on.
Preapproval: A preapproval is a document that tells you how much you can afford to take out in a home loan. Many lenders consider preapproval to be the first step in getting a mortgage. When you apply for a preapproval, your lender will ask you about things like your credit score, income, and assets. Your lender will then use this information to tell you how much you qualify for in a home. This can give you a rough budget to use when you compare properties.
Keep in mind that a preapproval isn’t the same thing as a prequalification. Prequalification usually doesn’t involve asset and income verification, which means that they aren’t as reliable as preapprovals. Make sure you get a preapproval before you begin shopping for homes.
Principal: Your principal balance is the amount that you take out in a loan. For example, if you buy a home with a $150,000 loan from your lender, your principal balance is $150,000. Your principal balance shrinks as you make payments on your loan over time.
Annual Percentage Rate (APR): This number reflects the total annual cost of taking out your mortgage loan. It’s different from your mortgage interest rate and includes some extra fees.
Adjustable-Rate Mortgage (ARM): An adjustable-rate mortgage (ARM) is a type of loan with an interest rate that varies depending on how market rates move. When you sign up for an ARM, you first get a short period of fixed interest. This is the introductory period of the loan and can last for up to 10 years. During your introductory period, your interest rate is usually lower than what you’d get with a fixed-rate loan. After the introductory period expires, your interest rate will follow market interest rates. ARMs have caps in place that limit the total amount that your interest can rise or fall over the course of your loan.
Balloon loan: A balloon loan, or balloon payment mortgage, gets its name from the large size of its payments. It’s a type of financing that requires a lump sum to be paid at some point in the mortgage term – most commonly, at the end. With a balloon loan, you choose to pay an interest-only mortgage or one that includes both principal and interest payments. Interest-only mortgages only require you to pay the cost of interest throughout your term with the entire balance due at the end.
Amortization: Home loan amortization is the process of how payments spread out over time. When you make a payment on your mortgage, a percentage of your payment goes toward interest and a percentage goes toward your loan principal. At the beginning of your loan, your principal is high and most of your payment goes toward interest. However, you chip away at your principal over time and pay less in interest. An amortization schedule can reflect consistent monthly payments and keep you on track to pay off your loan within the term.
Refinance: Refinancing happens on an existing mortgage. Essentially, you trade the original debt obligation in for a new one. Refinancing is beneficial for borrowers to create a more convenient payment schedule, a lower interest rate, or a different term. When considering refinancing on your mortgage, consider the closing costs associated with getting a new loan.
Underwriting: When a loan professional evaluates your application and verifies all your financial details, that’s underwriting. It’s important to ensure that you have the means to manage your new monthly payment.
Escrow: An escrow account is used to hold funds prior to closing, including your earnest money deposit. You might also pay into an escrow account to cover property taxes, homeowner’s insurance, and private mortgage insurance (if you have it).
Closing Disclosure: This is a document that you’ll be given at least three days before your closing date. It should detail all the final costs of your loan, as well as what you’ll be expected to pay on closing day.
Closing Costs: Closing costs are settlement costs and fees you pay to your lender in exchange for finalizing your loan. Some common closing costs include appraisal fees, loan origination fees, and pest inspection fees. The specific costs you’ll need to cover depend on your location and property type. Closing costs usually equal 3% – 6% of the total value of your loan.
Term: Your mortgage term is the number of years you’ll pay on your loan before you fully own your home. For example, you may take out a mortgage loan with a 15-year term and that means that you’ll make monthly payments on your loan for 15 years before the loan matures. The most common mortgage terms are 15 years and 30 years, but some lenders offer terms as short as 8 years.
Prepaid Costs: These also come up at closing and will go into your escrow account. They usually cover mortgage interest, property taxes, and homeowners insurance expenses that occur between your closing date and the date your first mortgage payment is due.
Homeowners Insurance: Homeowner’s insurance is a type of protection that compensates you if your home gets damaged during a covered incident. Common damages that are covered include fires, burglaries, and windstorms. In exchange for coverage, you pay your insurance provider a monthly premium. You’re not legally required to get homeowners insurance to own a home. However, your mortgage lender may require you to maintain at least a certain level of coverage for the life of your loan.
Property taxes: You’ll be required to pay property taxes to your local government. The amount you pay in property taxes depends on your home’s value and where you live. Property taxes fund things like police departments, roads, libraries, and community development. Don’t forget to factor in property taxes when you shop for a home.
Deed: A deed is the physical document you receive that proves you own your home. You’ll receive your deed when you close on your loan.
Title: A title is proof that you own a home. Your title includes a physical description of your property, the names of anyone who owns the property, and any liens on the home. When someone says that they’re “on the title” of a home, it means that they have some kind of legal ownership of the property. For example, if your parents were to help you purchase a home, they’d likely be listed on the title.
Chandra Liggins is a Global Mortgage Senior Loan Officer based in Rancho Cucamonga, California. Visit Chandra’s Facebook business page if you are looking for advice from a seasoned mortgage professional.