If you’re a first-time homebuyer, you might feel lost in a sea of mortgage-related jargon.
Amortization. Escrow. Origination fees.
There are so many terms, it can make your head spin.
To help take the stress off, we’ve compiled a list of common terms you might encounter while pursuing a mortgage. Below, we’ll define them in plain terms and provide some additional resources for you to learn more about some of the “trickier” terms.
Common Mortgage-Related Jargon
Adjustable-Rate Mortgage (ARM)
A type of mortgage that is defined by interest rates that change periodically throughout the life of the loan. The loan’s interest rate starts out fixed for a certain period of time and gets “reset” by your lender every so often. Lenders use two numbers—called the index and the margin—to calculate your new interest rate. Think of the index like a “benchmark.” It reflects general market conditions. The margin is a fixed percentage rate that the lender adds to the index. It is set at closing and will not change throughout the life of your loan. For a super detailed breakdown of ARMs, check out this consumer handbook from the Federal Reserve Board: https://files.consumerfinance.gov/f/201204_CFPB_ARMs-brochure.pdf.
This word is a lot more intimidating than its definition. Put simply, amortization is a fancy word for the act of paying off a loan with regular periodic payments. Lenders break up your payments into equal installments, with part of it going to the loan principal and the other part going toward interest. There are a lot of online “amortization schedule calculators” you can plug numbers into and see what your monthly payments may look like if you were to take on a mortgage of a certain cost.
Annual Percentage Rate (APR)
Your APR is slightly more involved than your basic interest rate. In addition to the interest rate, it incorporates things like points (see definition below) and any fees associated with the loan (including broker fees). That explains why your APR tends to be higher than your interest rate. It’s not just one charge; it’s a combination of charges. You can find more information about APR on consumerfinance.gov: https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-a-mortgage-interest-rate-and-an-apr-en-135/.
A home appraisal is the process of a state-licensed professional providing an unbiased assessment about the value of your home. In order to maintain fairness, your lender will contract your appraiser, typically through an appraisal management company. Sometimes, people get appraisals and inspections mixed up. The difference is that an appraisal is all about determining the value of the house, while an inspection involves assessing necessary repairs to the home and their costs.
A combination of expenses that get added to the purchase price of your property. “Closing” refers to closing on—or finalizing—the sale of the home. Includes costs like lender fees, title fees, and sometimes upfront costs for things like homeowner’s insurance. Also known as “settlement costs.”
A lot of definitions of what home equity is can seem kind of wordy and confusing, but it’s actually quite a simple concept. Basically, equity refers to the portion of the home that a buyer truly “owns.” For instance, if you make a down payment that amounts to 20 percent of your home’s purchase price, your home equity amounts to that 20 percent. You personally paid for that much of your home. The rest of the money used to pay for the house is on loan from the bank, aka your mortgage. As you continue to pay down your loan balance, you’re putting more money into the value of the home, thereby increasing your equity.
Escrow is similar to appraisal in the sense that it’s a service offered by a third-party during the purchase of a home. In short, an escrow agent holds onto a deposit that amounts to a small percentage of the home’s sale price from the buyer. This deposit is usually referred to as “earnest money” and proves to the lender that a buyer intends to complete the purchase of a home in good faith. In exchange for this earnest money, the seller puts the home up for sale. As a neutral third-party, an escrow agent will ensure that the conditions of the purchase agreement are met before the buyer or the seller receives their end of the bargain.
Fannie Mae is a cutesy nickname for the Federal National Mortgage Association (FNMA)…because that one is a mouth full. Fannie Mae was created by Congress as part of the Great New Deal to help provide funding to moderate-low income homebuyers. It paved the way for the financing of long-term fixed-rate mortgages, an option in stark contrast to short-term loans that were popular at the same time. Fannie Mae doesn’t outright provide loans. Rather, they purchase mortgages from banks so that banks can have more funds to provide more loans to borrowers. Read more about Fannie Mae (and Freddie Mac, see below) on the Federal Housing Finance Agency’s website: https://www.fhfa.gov/SupervisionRegulation/FannieMaeandFreddieMac/Pages/About-Fannie-Mae—Freddie-Mac.aspx.
A type of mortgage that has an interest rate that stays the same throughout the life of the loan. They are commonly 15–30 years in duration and tend to have higher interest rates than ARMs.
Nickname for the Federal Home Loan Mortgage Corporation (FHLMC). Has the same basic function as Fannie Mae (see definition above) in that they help banks make more loans available by buying mortgages. Freddie Mac tends to buy mortgages from smaller banks.
Good Faith Estimate
A Good Faith Estimate (GFE) is a form that a lender must provide you with when you apply for a mortgage. It provides you with important dates pertaining to the loan, as well as a summary of the loan terms. This can be instrumental in helping you to compare loan offers and gain a clear understanding of what a loan will cost you. See a sample of a GFE here: https://www.hud.gov/sites/documents/DOC_23706.PDF
Mortgage insurance is a tool that lenders use as a fall back in case a borrower falls behind on their mortgage payments. If you default on your loan, the mortgage insurer will still pay the rest of it. Read our article on mortgage insurance for a basic breakdown of the different types of mortgage insurance and how they work.
Origination fees are simply upfront fees that lenders charge for “originating” or creating a mortgage loan. The fee factors in the cost of administrative services like processing the application and underwriting the loan.
Mortgage points are fees that you can choose to pay your lender at the time of closing in exchange for a lower interest rate. One point is equivalent to 1% of the total loan amount. Long story short, you’re paying more money up front so that you can save money long-term over the course of the loan’s life.
A mortgage preapproval is a letter from a lender presenting you an offer for a loan under specific terms. After evaluating your credit report and financial history, the lender produces a preapproval to let you know how much you’re qualified to borrow.
The amount borrowed from the lender minus the amount you’ve already paid to the lender. The total refers to how much you still owe on the loan.
Refinancing is the process of applying for a new loan with the goal of replacing your existing loan. It’s usually done with the intention of lowering your monthly payments and/or interest rates. Check out our article on refinancing and when it may be right for you.
The company that sends you your monthly statements and manages the receipt of your mortgage payments. Different from your lender, which is the financial institution that provided you with the loan.
Underwriting is a process completed on behalf of a lender that allows them to assess how much risk a lender will face if they make the decision to grant you a loan. In short, they’re trying to prevent you from closing on a loan you can’t afford. Underwriters will take on tasks like looking into your credit history, verifying your employment, and analyzing your debt-to-income ratio.
Comment below if there are any terms you’d like to see added to our list.
Disclaimer: These articles are intended for general informational purposes only and do not substitute the advice of qualified mortgage professionals. Please always consult your mortgage broker or loan officer when it comes to making decisions.