Important Mortgage Terms You Should Know
If you’re buying a home for the first time, you’re probably hearing a lot of new and confusing mortgage terminology. Your real estate agent, broker, and banker throw around terms like “APR,” “LTV,” and “amortization” assuming you know what they mean. You likely just nod and try to look thoughtful, all the while feeling more and more lost.
We put together this quick guide of important terms to help you become a true master of mortgage jargon.
Interest Rate vs APR
Your interest rate is the amount you pay to the bank each year in interest on your mortgage loan. Your APR, or Annual Percentage Rate, includes the interest along with some other costs, such as broker fees, discount points (up-front fees that lower the interest rate), and some closing costs. Both the interest rate and the APR are expressed as a percentage, such as “3.5% APR”. The interest rate is useful for figuring out your monthly payment, while the APR is a better measure of the total cost of your home loan over the long term.
A pre-qualification is a letter from a lender which implies that based on the initial information supplied by you about your finances, the lender is willing to issue you a loan up to a certain amount. A pre-qualification isn’t the same thing as a guaranteed loan offer, but it can be a big help while house-hunting. Sellers will take you more seriously if you have a letter from a lender expressing your ability to qualify for a loan.
Debt-to-Income Ratio (DTI)
Your debt-to-income ratio, or DTI, is a figure that shows how much of your monthly income is devoted to paying off debt. Calculating it is easy: just add up all your monthly debt payments, then divide the total by your gross (pre-tax) monthly income. Lenders use your DTI to figure out if you would able to comfortably manage your mortgage payments. In general, you likely won’t qualify for any mortgage that would put your total DTI above 43%. Ideally, lenders prefer to see a DTI no higher than 36%, with no more than 28% going toward your mortgage payment. Generally, the lower your DTI ratio, the easier it will be to qualify for the loan you want.
Loan-to-Value Ratio (LTV)
Before approving you for a mortgage, lenders will look at the loan-to-value ratio, or LTV. This is the total amount of the mortgage loan divided by the appraised value of the home, expressed as a percentage. For instance, if you want to borrow $200,000 to buy a home that’s worth $250,000, the LTV is 80%. A smaller down payment would cause the LTV to increase. An LTV of 95% or higher is more dangerous for a lender, since they want the homebuyer to have some skin in the game, thus a higher LTV will likely mean a higher interest rate. Lenders reserve their best interest rates for loans with LTVs at or below 80%.
Amortization is a fancy name for the process of paying off your mortgage loan. Every time you make a payment, part of it goes to pay your interest and part – a smaller part at first – goes toward paying off the principal. As your loan amortizes, the percentage of each mortgage payment that goes toward the principal gets bigger, while the interest portion gets smaller. The rate at which your mortgage balance shrinks is called the amortization schedule. You can also engage in accelerated amortization by making extra payments toward the principal, so it shrinks faster.
Private Mortgage Insurance (PMI)
PMI stands for Private Mortgage Insurance and is required on most loans on which the down payment is less than 20 percent. Think of PMI like homeowner’s insurance, except for your lender. It protects them in the event you fail to pay your mortgage and subsequently default on the loan. PMI costs anywhere from $50 to $150 per month and upwards, depending on your loan amount, but may be canceled once you’ve paid down at least 20% of your loan, or your LTV reaches 80%. Appreciation can also cause your LTV to decrease so keep an eye on the value of your home to get rid of it faster.
Also known as discount points, these are optional fees you pay directly to your lender at closing. Essentially, it’s like paying interest up front. By doing this, you can enjoy a lower interest rate and monthly payments, for the life of the loan.
Knowing these terms can help you shop intelligently for a mortgage loan. That way, when you finally find the home of your dreams, you’ll have an easier time getting the mortgage of your dreams to go with it.
Ethos Lending is a new type of mortgage lender. We use technology to keep our operational costs as low as possible. From closing costs to interest rates, we have made it our mission to make the process of buying a home more affordable. Get in touch with one of our mortgage specialists to learn more.