8 Mortgage Definitions You Should Know

Essential Mortgage Terms Every Homebuyer Should Understand

A main area in which first-time homebuyers find themselves confused is the language of mortgages. With terms that may seem difficult to understand, it is important to educate yourself before diving into the world of home financing. Let’s simplify these mortgage terms and set you on the path to homeownership.

Adjustable Rate

An adjustable-rate mortgage (ARM) is a type of home loan in which the interest rate you pay may vary over the term of the loan. Interest rates are fixed for specified periods and then change yearly or monthly. Your monthly mortgage payment and interest rate can increase or decrease after the fixed period ends, depending on the market status.

Amortization

Amortization refers to how your monthly payment is calculated. If your loan is amortized, you pay off the loan balance with regular (on-time) payments over an extended period, decreasing the amount you owe to the borrower with each submitted payment. In most cases, home loans are amortized. Some loans do not fully amortize, which means you could still owe the borrower money after making all required payments.

Annual Percentage Rate (APR)

The annual percentage rate is the interest you are charged yearly for borrowing money from a lender or creditor.

Conventional Loan

A conventional loan is a mortgage loan that is not government-backed. Conventional loans originate from and are serviced through private lenders, such as banks and other financial institutions. Government-backed loans are subsidized and protect lenders against payment defaults.

Credit Report

A detailed statement prepared by the credit bureaus outlining your credit history. The report includes four categories: personal information, credit accounts, public records, and inquiries. Lenders will determine creditworthiness after analyzing the report summary.

Debt-to-Income or DTI

Lenders often request access to pay stubs and bank statements to calculate your debt-to-income ratio (DTI). This is the percentage of your gross monthly income (pre-tax) that goes toward monthly debt payments, such as your mortgage, car payment, and credit card bills. Lenders calculate your DTI to help determine your “creditworthiness” or “borrowing risk.”

Private Mortgage Insirance or PMI

Private mortgage insurance (PMI) is a type of home insurance that is sometimes required to secure a loan or a specific interest rate. PMI is arranged by the lender and provided by private insurance companies, and the homeowner pays premiums. It insures the lender against potential losses such as missed mortgage payments. PMI is usually required on conventional loans when the homebuyer supplies a down payment of less than 20 percent (Equity Invested) and is sometimes only needed until you meet a certain repayment threshold. If you fall behind on your mortgage payments, PMI does not protect you, and you can still lose your home through foreclosure.

Mortgage Points

Also known as “discount points” or “buying down the interest rate,” mortgage points can help homeowners reduce their interest rates. Points are not always required to be paid up front; they can sometimes be charged to the loan balance or paid by the seller.

Understanding the key mortgage definitions inspires you to make sound financial decisions but also helps you avoid common pitfalls. As you prepare for this significant investment, remember that knowledge is your best friend.