There are 5 Mortgage Terms You Need to Know and Here's Why...
, by Rob Kaufman
Whether you're getting a mortgage to purchase a home or you're looking to refinance your current home loan, knowing the true meaning of certain "mortgage terms" can help you make better decisions. Although you might recognize some of these terms below, see if there's something in their description that's different from what you might have originally thought.
Getting a mortgage can be complicated. Hopefully, knowing these terms can help make your next mortgage process a bit easier.
Here are the mortgage terms to know:
The APR is the true cost of what you'll be borrowing because it includes all expenses of the loan. These expenses include interest rate, points, mortgage broker fees and other charges. In summary, APR is the actual amount of money you will pay.
APR calculation can vary depending on the loan type. If you're in the midst of searching for a mortgage, you can use this APR calculator to get an idea of what your APR could be.
It's up to the lender to calculate the APR. And remember: they are required to disclose a loan's finance charges as well as its APR in order for you to properly compare loans.
Adjustable Rate Mortgage (ARM)
An ARM is a loan with an interest rate that varies (adjusts) depending upon market interest rates. Typically, an ARM has limitations on how much the loan's interest rate can adjust per year as well as the maximum amount the rate can be adjusted over the loan's lifetime.
An interest-only ARM consists of a set time period during which only interest is paid on the loan. Although the borrower's payment amount is reduced, no principal is being paid off. This could mean a longer lifetime for the loan and/or a greater amount of interest paid than a typical ARM. A Hybrid ARM offers a fixed rate for a period of time and then returns to a variable rate for the remainder of the loan's life.
Since some ARMS only adjust "up", you won't benefit if rates fall. So if getting an ARM, it's always best to plan for the worst-case scenario and make sure your budget can handle those upward moves.
Amortization Schedule
The process of paying off a debt over time through regular payments (in this case a mortgage) is known as amortization. With mortgage amortization, a portion of each payment goes toward interest and the remaining amount is applied toward the principal balance. The questions most people want answered before taking out or refinancing a mortgage is: how much will the payments be and what will they look like over time.
An amortization schedule is a table that details each periodic payment of your mortgage based on the results of an amortization calculator. The schedule will show you how much of your payment is going toward interest versus principal. On each line, it will also show you how much of the balance remains.
As you'll see when using the calculator, the exact amount applied to principal changes after each payment. As time goes on, more money is attributed toward principal... which is always nice to see!
Loan-to-Value
Lenders need to assess the level of risk they take on when underwriting a mortgage. To do this, they use the loan-to-value (LTV) ratio which is the difference between the property's appraised value and the total amount borrowed.
When a borrower requests a mortgage, the closer the loan amount to the appraised value (a higher LTV) the greater the risk to the lender because there is no equity built up within the property. So if there's a foreclosure, the lender might have a problem selling the home for an amount that will cover the outstanding mortgage balance.
For example, someone wanting a mortgage of $100,000 for a house appraised at $150,000 would have an LTV ratio of 66% - which can be considered high. The lender would then use that ratio to help decide whether to accept or deny the loan.
Private Mortgage Insurance (PMI)
PMI is a type of mortgage insurance typically required on conventional loans if your down payment is less than 20% of the home's purchase price. PMI would also be required if you're refinancing with a conventional loan and you have equity in your home less than 20% of its value.
PMI can be included in the cost of your loan. Although some lenders do not require PMI, those lenders will usually charge a higher interest rate for the loan. Make sure to figure out the numbers to see which would cost more in the long term: PMI or a higher interest rate.
There's also the option of waiting until you save 20% for a down payment (or, if refinancing, increase your equity to 20%) so you won't have to concern yourself with PMI at all.
myFICO members visit the myFICO forum to learn as much as they can about mortgages (and terms they're unsure of). Visit any time, day or night!
Rob is a writer... of blogs, books and business. His financial investment experience combined with a long background in marketing credit protection services provides a source of information that helps fill the gaps on one's journey toward financial well-being. His goal is simple: The more people he can help, the better.