Between the acronyms, abbreviations, and industry-specific jargon, it’s easy to see how the mortgage process can come with a learning curve. Good news: You don’t need to know all of the lingo to achieve homeownership, but there are a handful of mortgage definitions you should understand before you kick off the process. Here are our top ten:
#1. Interest Rate
Let’s cover one of the basics first. An interest rate is fundamental to all forms of lending. In its simplest form, interest is what you pay a lender to borrow money on top of your principal, or the original amount you borrow. While you’ll always pay back more than what you borrowed, a lower interest rate means you’ll pay back less “extra.”
A lot of things go into determining your specific interest rate, including the amount you’re borrowing, your down payment, your credit score and history, and the length (or term) of your loan. Oh, and market conditions. Market conditions can affect the environment around you—including whether or not you’re in a buyer’s or a seller’s market.
#2. Buyer’s/Seller’s Market
When you’re ready to buy a home, your real estate agent may tell you it’s either a “buyer’s market” or a “seller’s market.” The former, a buyer’s market, is better for you, the borrower, because it generally means there are more available homes than buyers, which means less competition and lower prices. The latter, a seller’s market, is more competitive—often leading to bidding wars and greater potential for losing out on the home you’ve had your eyes on due to increased competition.
In a seller’s market, where homeowners are looking for top dollar from buyers, it’s important to have a bona fide pre-approval from your lender. If you’re interested in knowing what you can afford to offer before you start your house hunt, get your free rate quote here.
A buydown is related to both your interest rate and the market you find yourself in, and it allows borrowers to use cash to temporarily lower their interest rate for a set amount of time—usually one, two, or three years. For example, a 3-2-1 Buydown might allow you to lower your original rate by 3% during your first year of homeownership, 2% during your second, and 1% your third before going back to your initial interest rate.
How are buydowns paid for? There are different methods, but one of the most common is the application of seller or builder credits, issued at closing. So, for example, if your seller offers a $15,000 closing credit, you may be able to apply that cash to the purchase of a temporary buydown. In a high-rate environment or a buyer’s market, where sellers are under a little more pressure to sell, this option could save you thousands of dollars over the lifetime of your home loan.
#4. Closing Costs
Speaking of closing credits, let’s go over closing costs. Closing costs typically include all of the different fees you’ll pay in addition to the price of your new home, like appraisal, attorney, escrow, and title fees, as well as credit report costs. More often than not, you’ll pay for those with one check at the end of your purchasing process (and they may be included in the same check you write for your down payment).
A good lender can help you plan for those fees ahead of time to ensure you have the cash set aside when the time comes to spend it.
Equity is the overall value of your home, minus your remaining mortgage balance. Like interest rates, your home’s value may fluctuate over time with market conditions, but as long as you owe less than what the property is worth, you’ll have equity.
Like interest rates, your home’s value may fluctuate over time with market conditions, but as long as you owe less than what the property is worth, you’ll have equity.
For example, if your home is worth $400,000 and your mortgage balance is $300,000, you’d have $100,000 in equity. You can increase your home’s value and subsequent equity by paying down the balance, or by remodeling or renovating the property.
Did you know that a mid-range kitchen remodel has a return on investment of almost 60%? According to Zillow, a $64,000 remodel can add almost $38,000 of value to your home.
For additional ideas, check out another of one of our recent blogs, The Renovating a House Checklist You Absolutely Can’t Skip.
#6. Loan-to-Value (LTV)
LTV, or loan-to-value, is a ratio used to describe the overall size of your loan versus the value of the home you’re buying. It will always be expressed as a percentage and comes from dividing the loan size by the home’s value. LTV is critical in determining your loan options, borrowing power, down payment, and whether or not you’ll need to pay private mortgage insurance (PMI).
Some home loans will require an LTV of 97.5%, which means you’ll need to put down just 3.5%. Other home loans require an LTV of 95% or less, which will require a higher down payment. Remember this general rule of thumb: The higher your down payment, the lower your LTV.
Remember this general rule of thumb: The higher your down payment, the lower your LTV.
#7. Debt-to-Income (DTI)
DTI, or the debt-to-income ratio, is the percentage of your gross monthly income that’s used to pay monthly debts, and it helps lenders determine how much of a risk you are. Borrowers with a low DTI are generally seen as better with money management, and therefore less risky. The exact formula for calculating front-end DTI is:
DTI = (Expenses / Gross Monthly Income) x 100
DTI is often split into two forms: Front-end and back-end.
- Front-end DTI compares the cost of your living expenses (i.e. rent or mortgage) to your gross monthly income.
- If your mortgage payment is $1,500 and your gross monthly income is $6,000, your front-end DTI would be 25%.
- Back-end DTI includes other financial obligations, like credit card payments, student loans, car payments, child support, alimony, and more.
- If your monthly debts amount to $825 and your gross monthly income is $4,750, your back-end DTI would be 17%.
So what’s a “good” debt-to-income ratio? We cover that in depth in this blog, but a lower DTI is always better. Different mortgages have different debt-to-income requirements, and lenders may have additional requirements beyond that to help mitigate risk.
#8. Funding Fees
Funding fees, like closing costs, are fees that borrowers pay to fund the loan and protect lenders from loss. Government loans like VA and FHA loans have funding fees, but those may be waived depending on individual loan circumstances. Your loan originator can help you find out if waivers are available for your specific loan type.
#9. Loan Originator
Speaking of loan originators, these professionals are different from mortgage brokers, because they’re representatives of the financial institution that’s helping buyers with the mortgage application process. A mortgage broker, on the other hand, is a licensed professional who works on your behalf to secure financing.
Basically, a loan originator works for a lender and a broker is an independent agent.
Once your application is complete and submitted (but before you get keys at the closing table), you’ll go through underwriting. Underwriting is the process lenders use to assess an applicant’s income, assets, credit, and risk.
During this process, lenders comb through your personal information and financial records to determine whether or not you qualify for a loan. They’ll determine your LTV, your DTI, your interest rate, and your closing costs, so it’s important to get your affairs in order well ahead of time to ensure the process isn’t held up.
Did these mortgage definitions help you better understand the mortgage process? Is there anything else we can clarify for you? Let us know on social media, check out our full glossary, or get in touch with one of our experts for more information. We’re always here to help!