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Commonly Used Mortgage Terms and What They Mean

4/15/2019

 
Being an educated home buyer includes knowing the type of mortgage you will use, costs associated with buying a home, etc. We’ve put together this little primer with commonly used mortgage terms to help you become a more educated buyer. All of the definitions come from Investopedia and we’ve added our thoughts on important points to keep in mind.

Adjustable Rate Mortgage (ARM): A type of mortgage in which the interest rate paid on the outstanding balance varies according to a specific benchmark. The initial interest rate is normally fixed for a period of time after which it is reset periodically, often every month. The interest rate paid by the borrower will be based on a benchmark plus an additional spread, called an ARM margin.

Keep in Mind: ARMs can start out looking appealing with low rates. Be sure you pay attention to the terms of the loan and how soon it will adjust.
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Annual Percentage Rate (APR): The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This includes any fees or additional costs associated with the transaction.

Keep in Mind: Your APR will be higher than advertised rates because of the addition of fees and other costs associated with the loan.

Closing Costs: The expenses, over and above the price of the property that buyers and sellers normally incur to complete a real estate transaction. Costs incurred include loan origination fees, discount points, appraisal fees, title searches, title insurance, surveys, taxes, deed-recording fees and credit report charges. Also known as, “settlement costs.”

Keep in Mind: Closing Costs can be a good tool to use in real estate negotiations. On certain transactions, your agent may recommend offering full price, but asking the seller to pay closing costs. As a seller, using a closing cost payment on counterproposals can go a long way towards making a deal.

Escrow: A financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate written or oral instructions or until obligations have been fulfilled. Securities, funds and other assets can be held in escrow.

Keep in Mind: Escrow offers protection for both buyers and sellers. Holding money in escrow while inspections are done protects buyers from sellers walking with their money. For sellers, having an earnest money payment in escrow shows the buyer’s commitment and ability to pay for your property.

Fixed-Rate Mortgage: A mortgage that has a fixed interest rate for the entire term of the loan. The distinguishing factor of a fixed-rate mortgage is that the interest rate over every time period of the mortgage is known at the time the mortgage is originated.

Keep in Mind: Fixed rate mortgages are often advantageous for home owners. For example, mortgage rates have been at a historical low for the past couple of years. Securing a fixed rate mortgage now, means you are locking in those lows and not subject to interest rate adjustments as on ARM loans.

Loan to Value Ratio (LVR): A lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is accepted, the loan will generally cost the borrower more to borrow or he or she will need to purchase mortgage insurance.

Keep in Mind: LTV is not the only criteria used when assessing mortgages. Working with a real estate agent and their recommended lender will help you find the best mortgage for your needs.

Mortgage Rate Lock: An agreement between a borrower and a lender that allows the borrower to lock in the interest rate on a mortgage over a specified time period at the prevailing market interest rate. The lender may charge a lock fee, which the borrower must pay if he or she does not lock the interest rate. Alternatively, the lender may charge a marginally higher interest rate to begin with, just in case the borrower chooses not to lock the interest rate.

Keep in Mind: Working with a reputable lender is key. Unscrupulous lenders may let lock sheets expire when interest rates rise.

Private Mortgage Insurance (PMI): A risk-management product that protects lenders against loss if a borrower defaults. Most lenders require private mortgage insurance (PMI) for loans with loan-to-value (LTV) percentages in excess of 80% (the buyer put down less than 20% of the home's value upon purchase). This allows borrowers to make a smaller down payment of 3% to 19.99%, instead of 20%, allowing them to obtain a mortgage sooner since they don’t have to save up as much money. Borrowers pay their PMI monthly until they have accumulated enough equity in the home that the lender no longer considers them high risk.

Keep in Mind: PMI only applies to conventional loans. Federal Housing Administration (FHA) loans have their own mortgage insurance requirements. Veteran’s Administration (VA) loans don’t require any mortgage insurance. Before you start shopping for homes, meet with a lender to discuss which loan(s) you qualify for.

Knowing commonly used mortgage terms is one step towards making you a more educated home buyer or seller. Take time to talk to your real estate agent and lender about the home buying and selling process. Ask for explanations of terms you don’t understand and do your own research. Remember, knowledge is power!​

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