Buying a home, especially your first home, can sometimes be a confusing process. With new terms like earnest money and title search jumping out at you from purchase contracts and mortgage documents, you may find your head spinning. That’s why we’ve compiled some of the common home financing terms you should understand when purchasing a home.
Annual percentage rate (APR) refers to the annual cost of a loan to a borrower, including the interest rate and any other costs associated with getting a loan. APR differs from your mortgage rate; click here to see how.
Buying a home includes a lot of different parties to perform services related to your home purchase. Closing costs are charged by your lender and third parties and are paid at the finalization of your home purchase, hence closing costs. To see what types of costs are usually included, click here.
Private Mortgage Insurance
Not to be confused with homeowners (hazard) insurance, PMI is something that protects the lender, not the borrower. Private mortgage insurance protects lenders in the case that borrowers default on their mortgage.
Not all homebuyers are required to pay PMI. Typically, homebuyers who have a down payment of less than 20 percent are required to carry it.
In real estate terms, title refers to instruments or documents by which a right of ownership is established (title documents) or to the ownership interest one has in the real estate.
To ensure there are no other rights of ownership, claims or liens on the home you’re purchasing, a title company will perform a title search to determine that the seller has the legal right to be selling the property.
An escrow is a financial instrument created in order to store money collected by a lender to pay for property taxes and hazard insurance when they become due by a third party. This ensures that a borrower has enough funds to pay for taxes and insurance.
Adjustable or Fixed Rate Mortgage
Also known as an ARM or FRM, adjustable and fixed refer to your loan’s interest rate. Adjustable rate mortgages have interest rates that are fixed for a specified term (3, 5, 7 or 10 years) and then adjust annually based on changes in a pre-selected index.
A fixed rate mortgage is exactly how it sounds. Your interest rate is fixed for the entirety of your loan term, unless of course you choose to refinance down the road.
In mortgage lending, your credit score is calculated from a combination of scores from the three national credit bureaus: TransUnion, Experian and Equifax. Lenders use your median score of the three, known as a FICO score, for credit representation.
Underwriting is the investigative portion of the mortgage process. Underwriters:
- Give conditions for approval/closing
- Verify information on a loan application
- Determine if borrower/home meet loan criteria
- Assess borrower risk
- Approve, suspend or deny loan applications
An amortization is the reduction of debt by a certain maturity date through scheduled payments of principal and interest. In the beginning of your mortgage, a larger portion of your payments goes toward interest until you reach what is called the “break-even point”.
Home equity is typically defined as the difference between the fair market value of your home and your outstanding mortgage balance. For instance, let’s say your home has $250,000 appraised value and your mortgage balance totals $100,000. Your home equity is $150,000.
Also referred to as “discount points”, a point equals one percent of the amount of a mortgage loan and are charged by a lender as a form of pre-paid interest. Borrowers who choose to pay for points upfront do so to receive a lower interest rate and a smaller monthly payment.
For more information about purchasing and financing your first home, download our free Mortgage 101 Handbook.
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