Understanding Mortgage Terminology
Updated: Dec 28, 2022
Purchasing a home is a smart investment. However, if you're purchasing a home for the first time, there is some terminology you need to be aware of regarding your future home mortgage. Here are some common words and terminology you'll encounter when you're looking for a home loan.
Adjustable Rate Mortgage (a.k.a. ARM Loan): An Adjustable Rate Mortgage is a home loan where the interest rate adjusts throughout the term of the loan. ARM Loans usually have an initial interest rate that is lower than that of a Fixed-Rate Mortgage. This low interest rate is locked for a set length of time. Once that time has expired, the interest rate can go up based on market factors. The lower initial interest rate helps those who cant afford a fixed-rate mortgage get financing for their home. However, the interest rate will most likely increase after the initial term of the low interest rate expires.
Annual Percentage Rate (APR): APR is the interest rate quoted by the lender plus additional home loan costs. Additional costs include origination fees, points, etc. APR is often higher than the stated interest rate. This is because the additional costs will alter the originally advertised interest rate accordingly.
Closing Costs: Closing costs are the expenses involved in finalizing a mortgage. Closing costs include lender/agency fees, loan origination costs, escrow payments, title insurance, attorney fees, etc. Closing costs are often shared between both the buyer and the seller.
Escrow: Escrow is at the end of the mortgage process where a neutral third party obtains the documentation and money involved in the transaction until the transaction is complete. An escrow account is also used to hold the property tax and insurance monies that are collected during payment of the loan.
Fixed-Rate Mortgage: A fixed-rate mortgage is a loan where the interest rate stays the same. It does not fluctuate while the loan is being paid off. Financing for fixed-rate mortgage loans are commonly spread out over 10, 15, 20, or 30 years. This type of loan is popular because there are typically no surprises. Since the interest rate remains the same, the monthly mortgage payments are static, and don't change year to year.
Points: Points are a percentage of the principal of the loan used to lower the interest rate of a loan. There are two types of points: Discount Points and Origination Points. Discount Points reduce the interest rate of a loan by having the lender pay more at closing. One point equals one percent. So, if you want to lower your interest rate by one percent, the borrow needs to pay one percent of the principal at closing. However, this does not lower the principal amount. It merely lowers the interest rate. Origination Points are used is the same fashion and utilized to cover the loan processing expenses.
Principal: Principal is the original amount borrowed from the lender. It does not include interest or other fees. Its the lump sum the borrower gets from the lender.
Knowing the terminology involved in your mortgage will help you stay on top of the mortgage process and allow the entire process to run smoothly. Read up on these terms and keep yourself out of the dark.