If you’re a first time homebuyer – or even if you’ve had your mortgage for over a decade – you might be confused about some mortgage terms. We’re here to help. At Patelco, we are all about your financial well-being – how you feel about your financial health. And we want you to feel informed, which is why we created this handy guide of definitions for common terms.
If you still have questions about a mortgage, contact one of our Home Loan Consultants or a certified BALANCE counselor. All Patelco members have complimentary access to BALANCE counselors online or on the phone, so you can get your questions answered quickly.
Adjustable-rate mortgage (ARM) – a mortgage where the interest rate may change based on changing market conditions (i.e. changes in the economy). Your mortgage documents will indicate if you have this type of mortgage and, if so, how your rate could change. Many ARMs also have a cap — the top interest rate that can be charged.
Amortization – the way your principal is paid down over time. At the beginning of your mortgage, most of your payment goes toward interest. As you get closer to the end of your mortgage term, more of your payment goes toward the principal.
Annual maintenance fee – A fee charged to some home equity loans and HELOCs for the duration of the loan.
Annual percentage rate (APR) – the total rate you will pay to the lender annually based on the amount financed. The APR is different from the interest rate and represents the true cost of your loan, including interest plus fees and any other one-time loan costs. Different lenders have different interest rates and costs, so the APR helps you compare accurately. A lender’s interest rate may look inviting, but its fees and other costs could change the game – so pay attention to the APR.
Application fee – a fee charged by some lenders for some mortgages, home equity loans, HELOCs and refinancing.
Basis point – a financial term where one basis point is equal to one one-hundredth of a percentage point. A full percentage (1%) is a hundred basis points, a quarter of a percentage (0.25%) is twenty-five basis points, etc. It’s useful to understand this term, because you may hear something like “the average national mortgage rate rose 5 basis points.” In this example, that could be from 3.89 to 3.94. View our current rates on our rates page.
Cash-out refinance – when you refinance your home with a new lender (or the existing lender) and take out some of your home’s equity in cash. For example, a homeowner of a $200,000 home has a property that originally had a $200,000 mortgage. She still owes $100,000 on the mortgage – meaning she has built up $100,000 in home equity. To convert a portion of that equity into cash, she could opt for a cash-out refinance. If she wanted to convert $50,000 of her equity, she could refinance and take out a new loan for a total of $150,000. The new mortgage would consist of the $100,000 remaining balance from the original loan plus the desired $50,000 that could be taken out in cash. The maximum amount of cash available to an owner in a cash-out refinance depends on the property's loan-to-value ratio (LTV). Many lenders won’t refinance a loan unless you have an LTV of 80 percent.
Closing - the last step in buying and financing a home, also known as “settlement.” The closing is when you and all the other parties in a mortgage loan transaction sign all the necessary documents. After signing all these documents, you become responsible for the mortgage loan – and you get to move in to your new home.
Closing costs - also known as settlement costs, these costs are the total amount of money you need to close the mortgage deal. Typical closing costs could include title insurance, escrow fees, lender charges, real estate commissions, transfer taxes, recording fees, attorney fees, title search fees, and mortgage preparation fees. All closing costs will be listed on the loan estimate that the mortgage lender gives you within a few days of completing your application.
The bottom line: you can expect to pay between 2% to 5% of the purchase price in total closing costs. On a $200,000 loan that means an extra $4,000 to $10,000.
Conforming mortgage loan – a loan that meets specific guidelines set by Fannie Mae and Freddie Mac. When you buy a home, you may want a conforming loan because eligibility, pricing and features tend to be standardized. The loan terms are usually reasonable, and the interest rate may be lower than on a nonconforming loan. One of the most notable things about a conforming loan is that it must be under a certain dollar limit set by Fannie Mae and Freddie Mac – this amount is based on the real estate market, so the amount eligible for a conforming loan in California is higher than one in Idaho.
Conventional mortgage loan – any home loan you get that isn’t guaranteed by a government program.
Credit report – a record of all of your borrowing transactions, this report indicates how much debt you have and your payment history.
Credit score – a score assigned based on information from your credit report. Lenders use this three-digit number to gauge your risk as a borrower. The higher your score, the less of a risk. A high credit score can also help you get a lower rate, which could save you thousands of dollars over the life of your loan.
Earnest money – money you give to show you’re serious about purchasing a particular home. Earnest money is generally 3% to 5% of the home’s cost; it goes into an escrow account until financing is arranged. Once financing is arranged, the money is credited to the purchase price.
In some cases where a buyer backs out or is unable to get financing, the earnest money deposit will be transferred to the seller. Make sure to work with a reputable, experienced real estate agent when making your offer on a home.
Escrow – a special account held by a third-party in a real estate transaction, i.e. not the buyer and not the seller. It’s a way to ensure that both the home buyer and seller are protected. The buyer puts money in the escrow account so that the seller knows the money is available, but the seller doesn’t get the money until the papers are signed and the buyer gets access to the home.
Escrow fees – fees charged to use an escrow account, typically paid to a title company or attorney.
Fannie Mae and Freddie Mac – government-sponsored enterprises chartered federally to buy mortgage loans from lenders. They aren’t owned by the government but instead by stockholders. Fannie and Freddie purchase home loans from lenders and service them. This frees up the resources of financial institutions so they can make more loans to others.
Federal funds rate – a rate that affects your mortgage rate. The exact definition (the rate that banks charge each other when they make loans on an overnight basis) is not really important to you as a potential homeowner – what’s important to know is that this rate can affects mortgage rates. It’s not the only thing that affects mortgages though – they are affected by a broad range of things in the larger economy.
Fixed-rate mortgage – an interest for a mortgage that stays the same over the life of the loan unlike an adjustable rate mortgage (ARM). For many buyers, a fixed rate is preferable because it allows them to better plan a budget.
Home equity – the part of your home that you actually own. The equity is the difference between the current value of your home and how much you owe. For example, if your home is worth $200,000 and you owe $175,000, you have $25,000 equity. If you owe more to the lender than your home is worth, you have negative equity.
Home equity line of credit (HELOC) - a line of credit based on the equity you have in your home. For example, if your home is worth $250,000 and you owe $150,000, you have $100,000 equity in your home. What portion of your equity you can borrow against depends on a variety of factors including your credit history and income – most lenders will finance 75% to 90%. This means that you could get a HELOC of $75,000 to $90,000 based on the example here.
Home equity loan - a lump-sum loan based on the amount of equity you have in your home. Most lenders will finance 75% to 90% of the equity you have in your home. This means that you could get a loan of $75,000 to $90,000 if you had $100,000 equity. A home equity loan is different from a HELOC – if you want more, you would need to apply for a new loan.
Jumbo mortgage – a loan that is more than the amount that Fannie Mae or Freddie Mac can service. These loans usually come with higher interest rates to make up for the higher risk involved. The maximum amounts may vary from time to time and state to state.
Lien – a type of ownership on a piece of real property. There are several common types of liens, including mortgage liens, contractor’s liens and tax liens. A first mortgage is the primary lien on your property and the most common type of lien. Basically, this means that since your lender has a claim on your home, you need to keep up with your payments or risk losing your property to foreclosure.
A contractor’s lien arises when a contractor does work on a property but is not paid for his or her work. A tax lien arises when taxes are not paid to the government for a property. Before property can properly change hands (be sold or otherwise transferred), liens must be paid off. Otherwise the new owner’s property is subject to those liens. A title company will help make sure there are no outstanding liens on a property during the home buying process.
When you complete your repayments to your lender (as set out in your mortgage contract), the mortgage lien goes away and you own your home free and clear.
Loan-to-value ratio (LTV) - a ratio that reflects the relationship between the value of your property versus how much you borrow. For example, you want to purchase a home for $200,000 and make a down payment of 20 percent (that’s $40,000). That means your loan would be $160,000, and you have an LTV of 80 percent. In order to avoid mortgage insurance, you need an LTV of 80 percent or less (because of a down payment of 20 percent or more). Many lenders won’t refinance a loan unless you have an LTV of 80 percent.
Mortgage – a financial instrument that puts the title to a home up as security (collateral) for the loan. Essentially, this means that the lender (Patelco, for example) has assurance that you will make your payments on your home. When you take out a home loan, the lender will probably require you to sign both a promissory note and a mortgage.
Mortgage broker – a person or company that connects potential home buyers to different lenders and can help you choose from different options.
Mortgage insurance – insurance that protects the lender in case the buyer doesn’t make his or her payments for a home. It’s also known as private mortgage insurance (PMI). Generally this insurance is required for borrowers who put down less than 20% and is added each month to the mortgage payment. In government-backed mortgages, mortgage insurance may take other forms such as an upfront fee and an annual premium. The cost typically amounts to another 0.15% to 1.95% on your mortgage each month – which can add hundreds of dollars to your monthly payment. After you have 20% equity in your home, you can request that this insurance be canceled. In most cases, lenders are required to remove the insurance once you have 22% equity in your home.
Origination fee - charges from a lender that may include the cost of processing your mortgage application, underwriting the loan and funding the loan, among other things. Known as an origination fee, it can be as much as 1% to 6% of the loan amount. This can have a particularly noticeable impact on a larger mortgage.
Points – an amount of money equal to 1% of the amount of the loan. In many mortgages, you may “buy” points when you first take out the mortgage, which means you’re paying more up front in exchange for a lower interest rate. When you buy points, you pay less over time. How much your interest rate gets lowered depends on the type of loan, the individual lender’s policies and the mortgage market at the time. Points can be a good idea if you believe you’ll keep the mortgage long enough to make back the cost.
Pre-approval – an official statement (in writing) from a lender letting you know how much you can borrow to buy a home. Your pre-approval letter can be used to prove to sellers that you are serious about buying, and that you can afford the home. To get a pre-approval, your credit will be pulled and your documentation checked to verify your ability to pay for the loan.
Pre-qualification – a less rigorous process than pre-approval that gives you a general idea of how much you can afford to borrow to buy a home. For the most part, pre-qualification uses information you provide without using documentation to verify. The amount is not “locked in” until you get a pre-approval.
Principal – the original amount you borrowed. A portion of each mortgage payment goes toward the principal and another portion goes toward the interest. As you pay down the principal, your equity in the home grows. You can make extra payments toward the mortgage principal – for example if your mortgage payment is $1,500 and then you pay an additional $100, the $100 will go towards the principal. Paying down the principal will reduce the amount of interest you pay over the life of the loan.
Promissory note - a promise by a borrower (someone who buys a home, for example) to repay a loan to a lender (Patelco, for example). When you buy a home, you will probably sign both a promissory note and a mortgage. The mortgage is what puts the title to a home up as security (collateral) for the loan.
Property appraisal fee – a fee that covers the cost of having a professional appraiser value the home you want and estimate the market value of the home. Fees for this can range from $300 to $500, but prices depend on the specific property and location of the appraisal. Unique properties, large houses, and remote locations typically cost more to appraise.
Rate lock – a guarantee that the mortgage interest rate won’t change between the day you make your offer and the day you close on the home (provided there are no changes to your mortgage application). Generally, the rate lock lasts from 30 to 60 days, although it can be longer. If interest rates are fluctuating noticeably, locking in a rate can save you money.
However, if you lock in a rate and then interest rates fall, you’re stuck with the higher rate. If closing takes longer than expected, extending the rate lock can be costly. In addition, your rate might still change if your application is altered – such as because of changes in your credit score, the type of loan you want, or the down payment amount.
Refinance – getting a new loan to pay off your existing mortgage. Often, homeowners choose to refinance when they can get a lower interest rate, especially if a lower fixed rate. Check out our article on refinancing to learn more.
Second mortgage – taking out an additional loan on your home using your equity. Examples of second mortgages include home equity loans and home equity lines of credit (HELOC).
Title – a document that shows legal ownership to a property.
Title company – a company that makes sure that the title to a piece of real estate is legitimate and then issues title insurance for that property. Title insurance protects the lender and/or owner against lawsuits or claims against the property that result from disputes over the title (i.e. disputes over ownership or over debts owed related to the property).
Title insurance – a type of insurance that guards against disputes about the title or about debts owed related to the property (tax liens or contractor liens). There is title insurance for both lenders and owners. Both guard against disputes about the title, such as tax liens or contractor liens. Lenders usually require homebuyers to have lender’s title insurance. You may also choose to have owner’s title insurance as further protection for yourself. Frequently, buying both types of insurance from the same company can help lower your cost.
Transaction fee – a fee charged by some lenders every time you make a withdrawal from your HELOC. (This term can also have other meanings in other financial contexts.)
Underwriting – the assessment of how much risk a lender takes on by approving your mortgage application. During the underwriting process, the lender looks at your income, assets, credit history, debt and other factors that may influence your ability to make your mortgage payments.
Source(s) consulted: Broadridge Financial Solutions, NerdWallet.