Mortgage Loans 101: Your guide to rates, terms, and repayments.
in Buying a House
If you’re starting to think about buying a house, you’re probably very excited — and maybe a little overwhelmed. Buying a house is a major milestone and something to celebrate, no doubt. It’s a reflection of your hard work, patience, and maybe even sacrifice.
But if you feel like you’re stumbling through a new language as you learn about mortgages, you’re not alone.
For example, what is a mortgage anyway? In its simplest terms, a mortgage is a loan used to purchase some type of real estate. Mortgage loans make it possible for many people to buy homes, unless you’re fortunate enough to pay for it outright.
As you embark on your journey, you may find that there’s jargon you may be unfamiliar with. From when you begin your research until the time you have the keys to your new house in hand, we’ll make sure you have a clear understanding of the mortgage terms to know in order to succeed.
Understanding Mortgage Terminology
Once you’ve committed to buying a home, you’ll soon thereafter need to start the mortgage application process. Because buying a home is a major financial investment, there’s a lot that goes into the process of applying for this type of loan.
First, you should know that there are different types of mortgages:
- Fixed-rate mortgage: With this type of loan, your monthly mortgage payment and interest rate will remain the same throughout the life of the loan.
- Adjustable-rate mortgage: Adjustable-rate mortgages are loans with monthly payments that may change over time. The monthly payments may vary based on fluctuations in the interest rate.
Although many people opt for a fixed-rate mortgage, there may be certain occasions — like when mortgage interest rates are very high — when an adjustable-rate mortgage might make more sense.
- Mortgage interest rate: By definition, an interest rate is the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding. A mortgage interest rate is the rate of interest charged for your mortgage loan.
And while mortgage interest rates certainly matter, you aren’t necessarily locked into them for life. You may be able to refinance your home in the future for a better interest rate.
- Refinancing: Refinancing your home means replacing your old mortgage with a new one (usually with a better rate or term). While there are typically fees involved, you can refinance to get better loan terms and lower your monthly mortgage payment. You may consider refinancing if your credit score increases or interest rates drop.
Before you start the process of shopping for a home, you’ll want to get preapproved.
- Preapproval: Getting preapproved for a mortgage means obtaining an advanced approval. Typically, you supply documentation of your income — including tax returns and bank statements — to a loan officer, who verifies the information, checks your credit score, and sends you a letter of preapproval (if approved). Including this letter in your offer can prove to be advantageous, as it shows the seller that the bank is willing to lend you a preapproved amount of money.
Note: You aren’t required to borrow from the lender who preapproves you — but taking this step shows sellers that you’re serious and ready to buy a home.
Mortgage terms to know before you start the homebuying process
In addition to knowing about the different types of mortgage loans, mortgage rates, and the preapproval process, there are a few more basic mortgage terms to know before you start shopping for a home:
- Lender: A lender is the person, institution, or organization that’s providing you the loan.
- Borrower: A borrower is the person who’s taking out a loan — or borrowing money — that they agree to pay back over a set period of time.
- Promissory note: This is a legal agreement between the borrower and the lender that includes all the details of the loan, including the total amount, interest rate, and mortgage term.
- Down payment: The down payment is the money you pay upfront towards home. The more you pay upfront, the less you have to borrow (and ultimately pay interest on).
- Loan-to-value ratio: The loan-to-value (LTV) ratio is a percentage comparison between the loan amount and your home’s appraised value. A higher down payment will lower your LTV ratio.
- Private mortgage insurance: Also known as PMI, private mortgage insurance is usually required with a down payment that’s less than 20% of the sales price. This protects the lender financially in case you default on the loan.
- Mortgage term: This is the time you have to repay your loan. Typical mortgage terms are 15, 20, or 30 years.
- PITI: This acronym stands for principal, interest, taxes, and insurance. Together, these four expenses are what comprises your monthly mortgage payment. The cumulative figure helps borrowers and lenders determine mortgage affordability.
- Point(s): A point is essentially prepaid interest that allows you to lower the interest rate on your mortgage. One point usually costs 1% of the loan. If you can afford to buy points upfront, you could owe considerably less in interest down the road.
- Total interest percentage: Also known as TIP, the total interest percentage is the sum total of how much you’ll end up paying in interest over your repayment period.
- Mortgage rate lock: This is an agreement between the borrower and the lender. The lender agrees to “lock-in” the current interest rate for a set period of time.
Mortgage terms related to closing on a home
Once your offer on a home is accepted, you’ll need to know about the closing process and what’s needed before the house becomes yours.
- Closing costs: These are fees you’ll pay on top of the purchase price of a home to pay the third-party service providers. Generally, closing costs are around 3-6% of the total purchase price.
- Home appraisal: An appraisal is the valuation of the home made by an authorized appraiser. This helps mortgage lenders decide whether or not they’re willing to give out a loan on a home. If a home’s purchase price is higher than its appraised value, the lender usually will only lend up that value. Appraisals keep lenders from loaning more money than a house is worth.
- Earnest money deposit: This is a deposit made by a buyer to show their seriousness in purchasing a home. It’s usually held in escrow until closing and then can be used toward the down payment of the home. The deposit can be anywhere from 1-10% of the purchase price.
- Bridge loan: A bridge loan is a way for homeowners to buy a new home while they wait for their current home to sell by using the equity in their current home to pay the down payment on the new home. Bridge loans are short-term — usually lasting up to one year.
- Equity: Equity is the portion of your home’s value that you actually own. If you borrow money to purchase a home, the lender “owns” part of the home, too. As you pay down your mortgage’s principal over the loan’s term, you build equity in your home.
- Escrow account: This account holds money paid by the homeowner as part of their monthly mortgage payment. It’s then used to pay year-end expenses, like taxes and insurance. Not all mortgages have an escrow account — in this instance, the homeowner pays these expenses directly.
Mortgage terms to know after purchasing a home
After purchasing a home, you’ll start repaying your mortgage under the rate and term per your agreement. Here are a few more terms to know when you become a homeowner:
- Prepayment penalty: If your lender charges a prepayment penalty (not all lenders do), you have to pay a fee if you pay off some or all of your mortgage early.
- Amortization schedule: Amortization is how your loan payments are spread out into monthly payments over time. An amortization schedule breaks down your monthly payments into how much you’re paying in interest and principal each month.
- Home equity loan: This is a type of debt that allows homeowners to borrow money against the equity in their homes. It’s usually a fixed-rate loan that provides a single payout of money.
- Home equity line of credit: Also known as a HELOC, a home equity line of credit is another way for homeowners to borrow against their home equity. HELOCs usually have a variable interest rate and are accessible on a revolving basis rather than as one lump sum.
Lafayette Federal Is Your Trusted Homebuying Partner
Simplify your journey by partnering with Lafayette Federal for your mortgage lending needs.
At Lafayette Federal Credit Union, we offer competitive benefits, including a 30-day close guarantee. If closing takes longer than 30 days, we offer a $250 closing cost credit (up to $2,000) for each day beyond 30 days. Additionally, Lafayette Federal offers nationwide financing, competitive rates, up to 100% financing options, loans up to $3,000,000, and money-saving rate discounts.