Buying your first home is an exciting milestone that signifies the start of a new chapter in your life. But homebuying isn’t always easy, especially if you don’t have the right information at your fingertips. For starters, if you are planning to take out a home loan, you must understand the home mortgage terms you are likely to encounter. At Community Credit Union, we are passionate about supporting new homebuyers as they figure out how to afford and finance a home, so we’ve put together a list of some of the most common lending vocabulary and what these words mean. We hope having this added knowledge instills you with more confidence as you move forward with your home-buying adventure.
Of course, if you’d rather skip right to getting personalized assistance with all of your home mortgage needs, you can call one of our mortgage lending professionals today at 978-968-2200 or send us an email. A CCU team member will be happy to answer all of your questions and walk you through the mortgage process step by step.
Common Home Mortgage Terms
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage is just one of many options you have when choosing a home loan. With this type of home mortgage, you’ll typically start off with a low fixed interest rate for a period of three to five years. After this initial period, you need to be prepared for periodic interest rate adjustments that could increase or decrease your monthly mortgage payments. Since there is a lot of unpredictability with ARMs, we always take the time to thoroughly explain the potential pros and cons of this type of loan to you.
A conventional loan is any home loan that is guaranteed by a private lender or by a government-sponsored enterprise like Fannie Mae. These programs are generally best for borrowers who have a good credit score and some savings set aside for a decent down payment. If you apply for one of these loans, we will evaluate your household income stream and your debt-to-income ratio. Conventional loans are popular among first-time homebuyers for many reasons, including that they generally offer lower interest rates that can either be fixed or adjustable and, depending on the loan, down payments as low as 3% of a home’s purchase price.
Debt-to-Income Ration (DTI)
Your debt-to-income ratio is typically one factor we use to determine whether to approve your mortgage application because it gives us a window into your financial situation. So, before you apply for a loan, it would be a good idea for you to know your DTI. The simplest way to figure out this ratio is to divide your total monthly debt, which may include things like rent, student loans, credit card balances, and monthly car payments, by your total monthly income. A debt-to-income (gross) ratio under 40% is generally very good, so if your DTI exceeds this number, you may want to consider ways to lower it, like paying down credit cards, reducing other monthly debts, or identifying additional income streams.
A down payment is an initial cash amount that you pay up front for your home. By making a down payment, you reduce the total amount that you’ll need to borrow, which lowers your monthly mortgage payments and the interest you’ll pay over the life of your mortgage. The amount of a down payment typically ranges from 3% to 20% of the total purchase price of your home. The actual amount you end up paying generally depends on the type of loan you qualify for as well as the savings you have available to put toward this payment. Some loan programs have a very low down payment requirement, making them particularly popular with first-time homebuyers.
If you get this type of mortgage, you are essentially locking in your interest rate and principal payment amount for the life of your loan. This predictability and stability can be helpful when you’re trying to budget for today and plan out your financial strategy for the long term. The best time to lock in a fixed interest rate is when rates are low, as doing so might save you thousands of dollars over the loan amortization, or payoff, period.
If a homeowner accepts your offer, we will request a home appraisal. This important process is undertaken by an independent and objective licensed professional and typically will cost you a few hundred dollars. The appraisal generally includes a walk-through of the interior and exterior of the home, as well as a review of the neighborhood, research into recently sold comparable homes in the area, and an analysis of public record data. All of this is compiled into a report that will be shared with you. If the value of the home matches up with the agreed-upon sale price or, even better, if the home appraises at a higher value, you can have peace of mind that you’re not overpaying for your home and the mortgage process can move forward. However, if the appraisal comes back lower than the agreed-upon sale price, we may not be willing to fund your loan because the amount you’re borrowing will be more than what the house could be sold for in the current market. In this scenario, you still have options. For example, you can try to renegotiate the price with the seller or you can pay the difference between the home appraisal and the actual value.
Many first-time homebuyers aren’t aware that a mortgage payment has four parts and that one of these parts is home insurance. (The other three parts are the principal, interest, and taxes.) Homeowners insurance is crucial protection to have, not just because we, as your lender, will require it, but also because it provides coverage to help you pay for expenses related to damage to your property, personal liability claims, and more.
Home Loan Underwriting
The underwriting process is what we, as your lender, will use to verify your income, assets, credit score, and debts and other liabilities, as well as the details of the property you’re buying. This step is done by our underwriting professionals, who evaluate every aspect of your finances to help us assess if you’re an acceptable credit risk. This is a very important step in the mortgage process because it directly impacts whether you’ll get final loan approval.
Loan amortization simply refers to the process of paying off your mortgage through regular monthly payments over a certain time-period.
Loan Amortization Schedule
Many homebuyers find it beneficial to create an amortization schedule, often called an amortization table, which shows exactly what they’ll be paying each month for their mortgage and how much of each payment will go toward the mortgage principal and the interest. Don’t worry, you don’t have to do these calculations by hand. In fact, there are online amortization calculators that you can play around with so you can see how different interest rates and terms may impact your monthly payment and how making an extra principal payment here and there might impact your loan term and interest payments.
Loan Estimate (LE)
A loan estimate is an important document you will receive from us after applying for a mortgage. It is crucial to review the LE carefully because it typically shows you the key details of the mortgage for which you’ve applied, including the loan amount, type, and term as well as estimates for your monthly payments, interest rate, and closing costs. The LE is not binding, meaning you are not committed to us or the loan until you accept it.
Mortgage Interest Rate
As is the case with pretty much any type of loan, you’ll be charged interest on the money you borrow to buy your home. The interest rate for your specific mortgage will typically depend on a variety of things, including the type and term of the loan you choose, your credit score, and bigger-picture financial factors like inflation and the 10-Year Treasury yield.
Going through the mortgage pre-approval process is essentially like filling out a mortgage application. We will ask for information that helps us verify your financial situation. This information may include tax returns, W-2 statements, pay stubs, bank statements, driver’s license, and social security number. Once you submit this information, we generally turn around a loan estimate within a few business days, giving you details on the potential cost of the loan. While getting preapproved does not bind you to a loan, it is usually a highly reliable estimate of the loan amount you can get approved for. When you get pre-approved, you also get a preapproval letter from us, which you can share with home sellers and their real estate agents to show that you’re an earnest buyer who is likely to be able to get the necessary financing to purchase their home.
At the very beginning of your house hunting adventure, it can be beneficial to go through the mortgage prequalification process. It doesn’t take a lot of work—usually, you just answer a few questions about your finances—and you get an estimate of what mortgage you might be able to afford. Having this initial estimated loan amount can help you focus your home search on properties that fit your budget. It’s important to know that this estimate is not a guarantee that we, as the lender, would loan you this amount. Because all the information is self-reported and not verified, the mortgage prequalification process is much less formal than the mortgage pre-approval process.
Mortgage Rate Lock
Since mortgage interest rates can fluctuate from day to day (and even multiple times a day), you may want to request a rate lock, which means that the interest rate on your loan will not change for a specified period, typically between 30 to 60 days, regardless of what is happening in the marketplace.
The mortgage term is the amount of time it will take you to pay off your loan with regularly scheduled payments. The length of the repayment period that we agree upon will impact both your monthly mortgage payment and the total amount of interest you will pay over the life of the loan.
You may be responsible for paying a mortgage origination fee to cover the cost of processing your home loan application. This fee typically costs between 0.5% and 1% of your total loan amount and is usually paid as part of closing costs.
Private Mortgage Insurance (PMI)
If you take out a conventional home loan and make a down payment of less than 20 percent, we will likely require you to purchase PMI. Doing so is a way for us to protect ourselves from the added risk of giving you a larger loan and requiring less cash from you up front. The PMI fee will be added to your monthly mortgage payment. However, you generally don’t have to pay PMI throughout the entire life of your loan. We may be able to cancel it once your mortgage principal reaches 78 percent of your home’s value or you’re halfway through your loan term.
Property taxes are one of the four main components that make up your monthly mortgage payment. (The other three parts are the principal, interest, and insurance.) Property taxes are collected by your local government and are typically used toward community programs, including providing support to schools, police and fire departments, and roadwork in your area. The amount you’ll owe in property tax is based on your local government’s tax rate and your property’s assessed value. Since this can be a sizable number, it’s essential to understand what your property taxes will be before you commit to buying a home. Finally, it’s important to know that even after your mortgage is paid off, you’ll still have to pay property taxes.
Truth in Lending Act (TILA)
TILA is a legal mandate dating back to 1968 that, among other things, requires lenders to be completely transparent with potential borrowers during the mortgage process. Specifically, TILA requires a lender to provide you with detailed loan information to prevent unfair lending practices like exceedingly high interest rates or hidden fees. This information helps you make an informed choice about your home loan lender.
Congratulations! By taking the time to familiarize yourself with the most common home mortgage terms, you’re one step closer to achieving your dream of homeownership. If you’re eager to continue on this journey and would like assistance and guidance from a local mortgage lending expert, please contact Community Credit Union today. We are dedicated to taking good care of you for the life of your loan and beyond.