13 Mortgage terms you absolutely must know before buying a house
Buying a house will probably be one of the largest financial decision you will make in your life time. At times, it can be lengthy and downright stressful experience.
To help you better understand and be prepared, we’ve put together some mortgage terms that you are likely to encounter frequently during the home buying process.
These condensed list of mortgage terms are especially important for first time home buyers as everything will be a new experience for them.
While it’s not necessary to know all, it’s important to know some basic mortgage terms so you don’t feel left out during the loan process and follow along with your loan officer.
Fixed rate mortgage
A fixed-rate mortgage is a home loan with an interest rate that will never change over the course of the loan. Hence, it is fixed. If you have the loan for 30 years, your interest rate stays the same for 30 years.
However, your monthly payment may fluctuate over the years because of property taxes going up or homeowner’s insurance rising or falling or finally shedding your PMI. But your interest rate is locked in and will never change.
Adjustable rate mortgage
Also known as ARM, this type of mortgage is basically the opposite of a fixed-rate mortgage. With an ARM, you will have a fixed interest rate for 3-10 years depending on your loan term, then interest rate adjusts according to indexed rate (usually the current prime rate or LIBOR). This mortgage is a bit of a gamble.
While payments will likely be lower in the first several years than fixed-rate mortgage, you may be forced to a much higher payment once fixed period is over.
One way to avoid this “payment shock” is to refinance into a fixed interest rate loan.
Private mortgage insurance or PMI for short
When homebuyers are not able to put down 20% or more of the appraised value as a down payment, they are required to pay monthly mortgage insurance (MI) or private mortgage insurance (PMI).
For conventional loans, PMI insurance isn’t something you will have to pay forever. Once you have accrued 22%+ of home value, you can ask your lender to remove your PMI. Otherwise, PMI is typically scheduled to fall off automatically in 10 years.
You can also refinance out of PMI later down the road when you have 20% or more equity via home value increase, pay down or combination of both.
Many new borrowers get confused with pre-qualified and pre-approved. Pre-qualification requires credit check and income documents to see how much you qualify for. While pre-qualification is a good start, it does not mean you are officially approved for a loan.
Pre-approvals carry much more weight because they require you to submit numerous pieces of financial documentation such as tax returns, pay stubs and bank statements. Once you have been pre-approved by a lender, it’s a commitment to giving you a loan as long as you are able to satisfy any conditions set by underwriter.
Loan to value or LTV
The loan to value or LTV ratio is the percentage of the loan amount to the appraised value or the sales price, whichever is less.
For example :
Purchase price: $300,000
Appraised value : $300,000
Max LTV allowed : 97%
Your down payment : 3% ($9,000)
Combined loan to value or CLTV ratio is the percentage of the loan amount combined from more than one loan.
For example :
Appraisal value : $400,000
1st mortgage : $300,000 (75% LTV)
2nd mortage : $100,000 (25% LTV)
Combined LTV : 100%
Most people will apply for this mortgage as it’s the standard mortgage loan.
In the past, borrowers were required to have excellent credit and be able to put down at least 20%.
Recently however, Fannie Mae and Freddie Mac have changed their guidelines to allow down payment as low as 5% or even 3% depending qualifications.
Typically, these loans require minimum of 620 credit score.
Short for Federal Housing Administration loans. FHA loans are offered to those borrowers who have less than perfect credit. Beyond relaxed credit qualifications, down payments can also be as low as 3.5% with credit score of 580 or higher.
Check you maximum loan limits here: FHA Loan Limit
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Appraisal is a process where you pay to get your home value checked by a licensed professional.
Lenders need to make sure their investments make sense. They can’t be expected to loan you $250,000 for a home that is really only worth $100,000.
This is where LTV comes into play. On a purchase transaction, max LTV allowed is based on lower of purchase price or appraised value.
Purchase Price: $300,000
Appraised Value: $290,000
Max LTV Allowed: 95%
Loan Amount: $275,500 (95% of $290,000)
Your Down Payment: (5% of $290,000) + (difference between purchase price and appraised value: $10,000) = $24,500
Purchase Price: $300,000
Appraised Value: $310,000
Max LTV Allowed: 95%
Loan Amount: $285,000 (95% of $300,000)
Your Down Payment: $15,000 (5% of $300,000)
*In this case, $10,000 difference between purchase price and appraised value is your additional equity!
Also known as homeowner’s insurance. This is required by the lender to get a loan and is designed to protect both lenders and borrowers in the event of damage covered by the insurance policy.
Points, discount points, or origination points
Points are prepaid interest.
The more points you pay, the lower your interest rate will be. One point is a charge equal to 1% of the loan amount.
Say you are borrowing $200,000 and a lender charges you two points – that would amount to $4,000. If they charge you three points that would be $6,000.
For purchase transaction, these points must be paid during closing along with other traditional closing costs. For refinance transaction, points can be rolled into your loan along with other traditional closings costs.
Home buyers who only plan on living in the house a few years most likely wouldn’t be interested in paying points. However, those borrowers who plan on staying in the home for many years may want to consider paying points upfront to snag a lower interest rate over 15-30 years.
Just what is included in the closing costs?
All of the fees your lender charges related to buying a home, as well as fees racked up from third parties such escrow & title, government fees, prepaid items, HOA dues, sewer dues, trash dues, home warranty, and etc..
When all is said and done, most people can expect their closing costs to be 2% to 3% of typical purchase price of Las Vegas homes (not including your points).
On purchase transaction, your real estate agent can negotiate with seller to pay for entire or partial closing costs. If seller is unwilling to pay for the closing costs, then you must pay for them.
For refinance transaction, you can roll into your loan amount for no out of pocket closing.
Escrow title company
An escrow or title company is the neutral 3rd party that handles all paper works and monies for transaction.
They will coordinate the transaction according to seller, buyer, lender’s instructions.
They also make sure your property’s title is clean of any lien(s) before you take possession and ensure clean title of your home.
Good faith estimate or loan estimate
Good faith estimate is now incorporated into a “Loan Estimate” or “LE” for short.
LE is a three to five page itemized lists of anticipated loan costs and closing fees passed from a lender to a potential borrower within three days of full application for a home loan.
LE contains important details about the loan you have requested and is designed to help you better understand the terms of your loan.
This is a new set of forms/disclosures required to take effect since October 3, 2015 instead of Good Faith Estimate.
If you find yourself confused on certain mortgage terms or loan process, please reach out to us. We’ll be sure to clear things up for you.
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