Mortgage Vocabulary: Terms You Need to Know

Why understanding mortgage terms are important

Buying a house can be intimidating, especially given all the specialized terms involved. What is an “ARM,” and how does it differ from a fixed-rate mortgage? You know you have a good credit score, but what does “debt-to-income ratio” even mean? Your home will probably be the biggest purchase you make in your lifetime. So, before you sign a mortgage or even begin your house search, it’s important to familiarize yourself with mortgage vocabulary.

When you close on a house and sign your mortgage documents, you’re entering into contractual agreements that have the force of law—and certain words have specific meaning in the law. Some mortgage vocabulary terms have different meanings in other contexts, so you want to be aware of what they mean before you sign on the dotted line.

Basic Mortgage Terms

You’ll want to get familiar with the following mortgage terms as you search for your new home. Before you sign any contract, make sure you consult an attorney if you’re unclear about any of the terms.

Amortization

A breakdown of the monthly payment schedule for a loan, including the amount you’ll pay towards interest and principal each month.

Appraisal

An estimate of a property’s current market value based on professional inspection and comparison to similar real estate in the area. If you’re selling your home, certain improvements can help you boost your property’s value.

Annual percentage rate (APR)

The total yearly cost of borrowing money from a lender, including interest, fees, insurance, and points, expressed as a percentage of your mortgage.

Adjustable rate mortgage (ARM)

A mortgage with an initial fixed-rate period, after which the rate goes up or down yearly depending on the market.

Balloon payment

A balloon loan amortizes only a portion of the total loan over the term period, and requires a large payment of the remaining balance due at the end of the mortgage term.

Closing

The completion of a real estate transaction when legal documents are signed, fees are paid, funds are disbursed, and the seller hands over the keys to the home.

Credit score

Your credit score is a number representing your creditworthiness to lenders, determined by your credit history, outstanding debts, payment history, and other factors.

Debt-to-income ratio (DTI)

Your total monthly debt divided by your total monthly income. It indicates what percentage of your income is used to pay off debt. The lower your debt-ratio, the better your chances of qualifying for a mortgage.

Down payment

The amount you pay upfront to the lender to secure the loan. Depending on the lender, down payments range from 3.5 to 20 percent of the selling price. The larger the down payment, the lower your monthly payments could be.

Earnest money

A payment you make in good faith to the seller to show that you are invested in buying the home. This money is ultimately applied toward the down payment.

Equity

The difference between the value of your home and how much you owe on your mortgage. If your home is worth $355,000 and you owe $200,000, you have $55,000 equity in your home. Equity increases as you make payments on your mortgage.

Escrow

A third-party account that you deposit money into before closing on the home. The seller can view the deposit in this account, but cannot take money out of the account until the home buying process is complete.

Fixed rate mortgage

A mortgage loan with an interest rate and an amortized payment rate that does not change over the term of the loan.

Foreclosure

When a borrower fails to make their monthly mortgage payments and loses all rights to their home as a result. The lender seizes and sells the foreclosed home to recover their losses.

Interest rate

The percentage of a loan that a lender charges each period, either monthly or annually, for the borrower to borrow money.

Jumbo loan

A mortgage loan in an amount that exceeds the limits set by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These loans generally have higher interest rates to account for the greater risk involved.

Loan term

The amount of time during which a borrower makes monthly payments toward a loan. Once a loan term ends the loan should either be repaid or refinanced for another term.

Loan-to-value ratio (LTV)

An assessment of lending risk that a lender considers before approving a loan, calculated by dividing the total loan amount by the appraised value of the home. For example, if you make a 15 percent down payment of $37,500 on a home worth $250,000, the loan total would be $212,500, and your LTV is 85 percent. If your LTV is 80 percent or higher, you may not need mortgage insurance.

Monthly payment

The installments paid to a mortgage loan every month. Your monthly payment goes toward both the principal balance and interest.

Mortgage

A loan that allows you to borrow money to buy property and repay the debt, plus interest, in monthly installments.

Origination fee

A fee that covers the costs of setting up a mortgage loan.

Private mortgage insurance (PMI)

Insurance that protects the lender in case the borrower fails to repay the loan. A down payment of 20 percent or more typically prevents you from needing PMI.

Points

Fees paid to the lender at closing that lower your interest rate, but cost you more upfront. Generally, one point equals one percent of your total loan.

Principal

The balance owed on your loan minus interest. It is reduced when you make payments.

Property tax

An annual payment made to the government of the city in which your home is located. It is determined by the area and the type of property.

Refinance

A renegotiation of the terms of a loan in order to accommodate new circumstances, for example extending the term period or changing the interest rate to match current market rates.

Make informed decisions on your way to financial freedom

Whether you’re buying a new home or refinancing an existing one, it’s absolutely crucial that you have a solid handle on mortgage vocabulary. Similarly, learning how to deal with debt, money, and planning for your future doesn’t need to be difficult as long as you educate yourself. We’ve developed a simple-to-follow guide to help you find the tools you chart a better financial future. Get started by downloading our free guide right now.