If you’re applying for your first mortgage, you’re probably seeing a lot of confusing terminology for the first time. Maybe you’ve recently heard something along these lines: “Based on your FICO, you can get a lower APR and avoid PMI if you pay for half a point and lower your LTV.”
People who work in the lending industry tend to specialize in technical mumbo-jumbo. Rocket Mortgage® by Quicken Loans® aims to bring the mortgage process to a level anyone can understand.
If you’re trying to navigate the mortgage waters, let’s give you a quick rundown of some key mortgage terms so you can understand what they mean.
In an appraisal, someone independent of the lender, buyer or seller evaluates the property to determine the fair market value of the home. The determination is based on its characteristics as well as recent sales of comparable properties in the area.
The appraisal is kind of a big deal because the lender cannot lend you an amount greater than what the property is worth. If the appraisal comes in lower than your offer amount, you can pay the difference between the appraised value and the purchase price at the closing table. Or, you can try to renegotiate the sales price with the seller.
If neither of these options is successful, you’re able to nullify the purchase agreement and get your earnest money back.
APR: The Real Interest Rate
When you’re shopping for a mortgage, you’re going to see two different rates. You’ll see one rate highlighted and then another rate, labeled APR, next to it. The interest rate is the cost for the lender to give you the money based upon current market interest rates.
APR (annual percentage rate) is the higher of the two rates and includes the base rate as well as closing costs associated with your loan, including any fees for points, the appraisal or pulling your credit. We’ll have more on points and appraisals in a minute.
When you compare interest rates, it’s important to look at the APR, rather than just the base rate, to get a more complete picture of overall loan cost.
Earnest Money Deposit
Despite the virtue to be earnest and tell the truth, this isn’t a check we get for our honesty.
Instead, your earnest money is a check you write when a seller accepts your offer and you draw up a purchase agreement. Your deposit of money is a show of good faith to the seller that you’re serious about the transaction.
If you ultimately close on the house, this money goes toward your down payment and closing costs.
An escrow account is for funds to be held for future required payments. In the context of your mortgage, most people have an escrow account so they don’t have to pay the full cost of property taxes or homeowners insurance at once. Instead, a year’s worth of payments for both are spread out over 12 months and collected with your monthly mortgage payment.
Your escrow amount is analyzed once a year by your lender to ensure the correct amount is being collected to pay for taxes and homeowners insurance.
The FICO® Score was created by the Fair Isaac Corporation as a way for lenders and creditors to judge the creditworthiness of a borrower based on an objective metric. Clients are judged on payment history, age of credit, the mix of revolving versus installment loans and how recently they applied for new credit.
The scoring range is between 300 and 850. Credit score is one of the main factors in determining your mortgage eligibility.
This is an optional (though highly recommended) step in your purchase process. You can hire an inspector to go through the home and identify any potential problems that might need to be addressed either now or in the future.
It’s a good idea to go through the home with the inspector so that you get an idea of what parts of the home need attention. If you find things that need to be fixed or repaired, you can negotiate with the seller to have them fix the issues or discount the sales price of the home.
This step is commonly confused with an appraisal. While an inspector gives you a heads up about issues, they don’t actually place a value on the house as an appraiser would.
LTV may sound like the latest and greatest liquid crystal display technology for your television, but it’s actually loan-to-value ratio, one of the metrics your lender uses to determine whether you can qualify for a loan. All loan programs have a maximum LTV. It’s calculated as the amount you’re borrowing divided by your home’s value.
You can think of it as the inverse of your down payment or equity. For example, if you have a 10% down payment, you have a 90% LTV.
Typically, we think of the mortgage as specifying the terms of your loan, but that’s actually handled in something called a mortgage note. The mortgage note specifies things like the interest rate and term of the loan as well as when payments are to be made.
You may also see points referred to as prepaid interest points or mortgage discount points. By prepaying some interest upfront, you can get a lower interest rate.
One point is equal to 1% of the loan amount, but you can buy them in increments all the way down to 0.125 points.
For more on points and whether you should buy them, check out this article on getting the best possible rate.
Next up in our tour of acronym soup are PMI and MIP, or private mortgage insurance and mortgage insurance premium, respectively. Both of these are types of mortgage insurance to protect the lender and/or investor of a mortgage.
If you make a down payment of less than 20%, mortgage investors enforce a mortgage insurance requirement. In some cases, it can increase your monthly payment of your loan, but the flipside is that you can pay less on your down payment.
Conventional loans have private mortgage insurance, which comes in two flavors: borrower-paid mortgage insurance (BPMI) and lender-paid mortgage insurance (LPMI).
BPMI is pretty straightforward: an extra monthly fee. LPMI programs, like PMI Advantage, allow you to avoid the monthly mortgage insurance payment in one or a combination of ways. The first option is to take a slightly higher rate than loans that have BPMI. You may see the second option sometimes referred to as single-payment or single-premium mortgage insurance in which you avoid the higher rate by paying a one-time fee upfront. You can also make a smaller one-time payment at close and employ a combination of both options.
FHA loans have MIP, which includes both an upfront mortgage insurance premium (can be paid at closing or rolled into the loan) and a monthly premium that lasts for the life of the loan if you only make the minimum down payment at closing.
Now that you have this post in your back pocket, you should be able to go through the mortgage process without feeling like this is all alphabet soup.
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