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Decoding Mortgage Terms

Buying a home is one of the biggest financial choices most of us will make. Unfortunately, not all mortgage lenders take the time to ensure potential borrowers understand how the process works, the different types of loans available, and which products are the right match for each person's financial situation.

If you're thinking about buying a home, then it's crucial to educate yourself about mortgage terminology and mortgage vocabulary. We know the lingo can be a little confusing, so we've broken it down.

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A real estate appraisal essentially determines how much a house or property is worth. Appraisals are assessed by third parties for a fee, which varies depending on the size and type of the property, but typically runs somewhere between $800 and $1,000 or more. Price is determined by the size of the property and type of structure as well as location. Appraisals are usually done when a home is sold, if you want to open a home equity line of credit, or if you're trying to refinance your existing home loan.

APR (Annual Percentage Rate)

The APR is typically more accurate than the interest rate when comparing loans. APR calculates the yearly finance cost of the mortgage in the form of a percentage rate. Unlike the interest rate on a loan, the APR takes into account the fees and points you pay to the lender, giving you a more complete picture of what you'll end up paying.

Remember: use caution when comparing different loan types, like a fixed rate loan to an adjustable rate loan. The interest rate on an adjustable rate loan can change and go up or down, while the interest rate on a fixed-rate loan won't change. More on that later!

Amortization, or Amortized

Amortization refers to spreading loan payments in equal amounts over a set amount of time. For example, if a loan's amortization period is 20 years, then your loan payment would be the same amount each month for 20 years.

Adjustable Rate Mortgage (ARM)

Unlike a fixed rate loan, payments for an ARM can move up and down as the index rate fluctuates during the life of the loan. Most ARMs have an initial fixed-rate period during which your rate can't change, followed by a longer period during which your rate can change during the remaining years on the loan.

For example, a 5/1 ARM is a typical product. This means that your interest rate won't change for the first 5 years, which in this case is the introductory period. The "1" means that the interest rate can change every year after, which is after the introductory period ends.

Why get an ARM? Generally, the initial rate is lower than a fixed rate, BUT since you can't predict future rates, you won't know for certain what you'll be paying in the future. ARMs do come with “caps” to prevent your interest rate from changing drastically. Caps are structured differently by lender and are designed to limit the amount of change year-to-year and over the life of the loan.

If you're interested in an ARM, make sure you understand how they work AND the maximum amount that you could end up paying after the introductory period is over. offers a helpful article that explains how ARMs work more thoroughly.

Balloon Loan

Some mortgages allow you to make interest-only, or near interest-only, payments for a period of time, usually 3 or 7 years, before requiring that the loan be paid in full. With a balloon loan, your monthly payment may be calculated based on paying the loan back (amortized) over 30 years, but at the end of the balloon term (say 3 or 7 years), you must pay the remaining amount of the loan in full—possibly by refinancing.

You may save money by having lower payments at first, but you risk having a significantly higher mortgage payment in the future if interest rates increase during the term of your balloon loan.

Closing Costs

Closing costs are the fees that you'll pay your lender and/or third parties during the final steps of getting a mortgage. The closing costs will be detailed in the Loan Estimate. These fees include loan origination fees, legal charges, taxes, title insurance, appraisal fees, credit report and the cost of processing the loan. Closing costs usually range between 3-6% of the property price.

Good Faith Estimate/Loan Estimate

The Loan Estimate (LE) is an estimate of closing costs, such as fees charged by the lender, and the necessary expenses to acquire a home loan. Your lender is required to supply you with your LE within 3 days of a completed application.

Debt-to-Income Ratio (DTI)

This ratio (DTI) is usually calculated when you submit a mortgage application. DTI is used to see the total amount of debt payments you make compared to how much you earn. It is the percentage of your gross income (paycheck amount before taxes and other deductions come out) that's devoted to paying off debt each month. Most lenders will want no more than 36 to 42% of your gross income to go toward monthly debt payments. That includes home loans, car payments, minimum credit card payments, student loans, and personal loans.

Discount Points

Discount points are the amount you pay in exchange for a lower interest rate. Discount points, like loan origination fees, are expressed as a percentage, such as 1.5%. That percentage is applied to your loan amount to determine the dollar cost of obtaining a discounted rate.

Investopedia explains it like this: Each discount point generally costs 1% of the total loan amount and, depending on the borrower, each point lowers the loan's interest rate by one-eighth to one-quarter of a percent. Discount points are tax deductible only for the year in which they were paid.

Down Payment

The down payment is the amount of cash you put toward purchasing your home. It is subtracted from the sales price when calculating the total amount that will be borrowed or financed. Lenders usually want at least 10 percent down, but depending on the type of mortgage you choose you may be able to put down a lower percentage. The best rates and terms are often offered to borrowers who put more money down. Plus, if you do put more money down, you can save money each month with a lower monthly payment, and, generally speaking, pay less in interest.

Interest/Interest Rate

Interest is the amount charged for borrowing funds and is expressed as an annual percentage of the amount of the loan. The interest rate is used to calculate your monthly mortgage payment based on the amount of time you have to repay the loan.

Loan-to-Value Ratio

The Loan-to-Value Ratio (LTV) is the ratio of the amount borrowed in comparison to the value of the home. This ratio is expressed as a percentage. The higher your down payment (or your equity in the home if you're refinancing), the lower your LTV. For example, if you are purchasing a home and make a 20% down payment, your LTV will be 80%.

Title and Title Insurance

A title or deed is the legal document that proves you are the legal owner of a home. Title insurance is a policy to protect home buyers and mortgage lenders from damage or financial losses caused by or due to title defects. A fee is paid to do a search of past ownership claims to a piece of property and protects a buyer should someone come forward to make a claim to the property (usually because of unpaid taxes or property disputes).

By understanding the most common mortgage terminology, you can eliminate confusion in the home buying process AND help ensure that you're in the right mortgage for your situation.

A home loan is the largest investment you will make, so be sure to ask as many questions as you need to fully understand everything!

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Whether you're looking to create a monthly budget for the first time, buying a home or refinancing, your neighborhood branch is here to help. Happy hunting!

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