First-time homebuyers are faced with many new terms. Unraveling the language of lenders trying to sell them on a particular mortgage program can be intimidating and frustrating. You need a concise explanation of what the terms really mean. Unfortunately, your lender may not be the best resource to turn to for definitions.
Here are some basic terms associated with mortgage loans that every educated consumer should be familiar with.
Principal: This is the amount of money given to the seller and other parties on your behalf by your lender.
Interest: Interest is the cost that you pay for borrowing money from a lender. Rather than a flat fee, interest is charged as a percentage of the amount of money that you have borrowed through your mortgage.
Amortization: Amortization is the breakdown of the payments that you will make on your mortgage loan and the way that payments are applied against the amount due. In a traditional mortgage loan, during the first half of the repayment schedule, about half of your funds are applied to interest and half to the principal. Over time, you pay more towards the principal and less toward the interest. The interest is charged at the beginning. Usually beginning in year 16 of a 30-year mortgage, your payments are applied entirely to the principal of the loan.
Downpayment: A down payment is the amount of money that you pay up front toward the cost of a new home. Most lenders require that you pay a specific percentage of the home’s purchase price before the mortgage can be finalized. Often this is 10 or 20%, but sometimes no down payment is required.
Closing Costs: Closing costs are the transaction costs associated with buying a home. These costs are above and beyond the cost of the home itself and include things broker costs, commission fees, title transfer fees, taxes, and possibly other costs. Find out ahead of time how much your closing costs will be so that you are adequately prepared for your closing. Sometimes sellers cover part or all of the closing costs, so this can be part of the negotiation.
Insurance: Two different insurance-related costs are associated with most mortgages. The first is property insurance, which protects both you and the lender from catastrophic loss and indemnifies you should someone be hurt on your property. The second is private mortgage insurance (PMI). Usually PMI is required when you cannot pay at least 20% of the home’s purchase price as a down payment. PMI protects the lender in the event that you default on the mortgage loan. Fortunately, PMI is not required for the life of the loan. Once you build up 20% equity in your home, the PMI requirement can be lifted. Speak with your lender about this before finalizing your mortgage.
Appraisal: An appraisal is required for mortgage approval. The lender will arrange for an independent valuation of the property that you intend to purchase.
Buy-Down: Some lenders give homebuyers the option of paying a larger percentage of the home’s purchase price or paying a percentage of the interest on their mortgage loan to reduce the interest rate or the monthly mortgage payment.
Escrow: An escrow account is established in the homebuyer’s name by the mortgage lender. The lender transfers a specific amount of the monthly mortgage payments to this escrow account throughout the life of the loan to cover real-estate taxes, PMI (when required), and other costs associated with homeownership.
Other terms are associated with home mortgages, but this general guide should provide you with a basic vocabulary for speaking with lenders about their mortgage offerings. Ask how escrow, PMI and buy-downs are handled. Being familiar with these terms can help you decide which mortgage program is the best option for you.