If you have ever tried to get or refinance a mortgage, you may have felt like you were in a foreign language class: some of the words seem familiar but you aren’t sure you know exactly what they mean. PMI, APR, escrow, jumbo … and on and on. Here we decipher some of the most common terms you are likely to come across, plus give you the scoop on why they are important.
Adjustable-Rate Mortgage (ARM): A loan with a rate that can change from time to time. Adjustable rate loans are tied to an index such as the prime rate or LIBOR and will change according to a schedule laid out in the loan documents.
The Scoop: Super-low introductory “teaser” rates that got a lot of homeowners in trouble during the housing boom and bust are largely gone, but ARMs are still available. When interest rates are extremely low, however, the benefit of a slightly lower rate may not be worth the risk that the rate (and payment) can rise in the future.
Annual Percentage Rate (APR): The interest rate expressed as an annual rate. When it comes to mortgages, the APR is always higher than the interest rate (or “note” rate) because it includes additional costs such as points or mortgage insurance (if applicable), and other fees associated with the loan.
The Scoop: A lower APR isn’t always your best choice. If you don’t want to pay closing costs, for example, or if you plan to be in a home for a relatively short period of time, a higher APR with lower out-of-pocket costs can be the better financial choice.
Appraisal: An evaluation of a property’s value on a specific date. Appraisals are prepared by licensed professionals.
The Scoop: A value you see online may be far different than what an appraisal determines. Appraisers must rely on “comps” — what similar properties in terms of age, style, size, etc. sold for recently. If there are no recent comparable sales or a property is very unusual, it can make it more difficult to get an appraisal that will be acceptable to a lender if financing will be involved. That’s something to keep in mind if you are thinking about buying a “one of a kind” house.
Broker: A mortgage broker typically works with multiple lenders for which it will take and process loan applications.
The Scoop: A good mortgage broker will shop for the best loan for a client, depending on that client’s needs and qualifications. Don’t assume going through a broker will cost more. In the sometimes crazy world of mortgage financing, the broker should have access to competitive — or even better — rates than an applicant can get by going directly to the same lender. However, some loan officers (brokers as well as in-house lenders) have put their own financial interests before that of their clients, so choose a mortgage company with a solid reputation and track record.
Closing Costs: Costs paid by the borrower and/or the seller if a home is sold rather than refinanced. May include the appraisal; points; document processing, tax service, underwriting, and/or application fees; lender or broker fees; credit report; flood certification; inspection; and/or title fees and possibly more. Typical closing costs vary by state though the national average in 2012 was $3,754, according to Bankrate.com.
The Scoop: Some lenders offer no closing cost loans but they mean different things to different lenders. Sometimes they refer to no lender costs, sometimes to wrapping the closing fees into the loan, and sometimes to getting a lender credit to pay for all the closing costs. Joseph Kelly, president of ArcLoan.com, has been helping to educate borrowers on the value of these loans since 1998. He says, “A true no closing cost option provides a credit from the lender to offset all of the closing costs on a mortgage. It is the best option for borrowers who may only be in their home five to seven years, or if interest rates may drop further in the next couple of years.”
Conventional: Conventional loans or financing refers to loans that meet the funding criteria of Fannie Mae or Freddie Mac. This is in contrast to government-insured loans (such as VA or FHA) or portfolio loans (loans that a lender plans to hold rather than package and sell).
The Scoop: Conventional loans have been more popular in recent years, but don’t limit your search to conventional financing. An FHA or VA loan may offer a lower downpayment, for example, or may be a better choice if your credit scores aren’t really high.
Credit Report: A credit report details a borrower’s payment history and information about certain public record items such as bankruptcies, judgments or tax liens. They are compiled by three major credit reporting agencies (CRAs): Equifax, Experian and TransUnion.
The Scoop: Most mortgage lenders will review a “tri-merge” credit report that contains a borrower’s history from all three of the major CRAs. If more than one person is applying for the loan, each borrower’s credit reports will be reviewed. It’s a good idea to review your credit reports and credit score at least three months before you apply for a mortgage so you’ll have plenty of time to fix any mistakes you find.
Escrow/ Impound Accounts: The lender collects money each month from the borrower as part of the monthly payment to cover the cost of property taxes and/or hazard insurance premiums, which are typically then paid by the lender once or twice a year.
The Scoop: Your lender may or may not require an escrow/impound account. Even if one isn’t required, you may want to think about one since it can make it easier to budget for these large expenses. And although you may think of the cost of insurance and taxes as part of your monthly payment, it’s smart to shop each year to make sure you aren’t overpaying for insurance or on your property taxes.
FHA: FHA loans are insured by the Department of Housing and Urban Development (HUD) and feature low down payments. In addition, certain closing costs can often be included in the loan and credit score requirements can be more flexible than some conventional loans.
The Scoop: These loans require the borrower to pay a Mortgage Insurance Premium (MIP), which adds to the monthly cost of the loan. Recent changes to the FHA program will require borrowers to pay MIP for the entire life of the loan.
Fixed Rate: Your interest rate is fixed at a certain rate for a specific period of time. For example, a 30-year fixed rate means your rate is fixed for 30 years.
The Scoop: A fixed rate doesn’t mean your payment can’t change during that time, however. If your payment includes taxes or insurance and the amount you pay for them change, your payments will change as well.
Good Faith Estimate (GFE): A good faith estimate provides an estimate of your closing costs and loan terms if your application is approved. You must receive one within three business days of applying for a mortgage.
The Scoop: A GFE can be a helpful tool for understanding what a loan may cost, but it doesn’t mean that’s exactly what you will pay. You can use a GFE to shop around or to compare different loan options (lower rate with higher closing costs vs. higher rate with lower closing costs, for example). Certain fees that have been quoted can’t change, or can’t change by more than 10%, though third-party fees can differ from what’s quoted in the GFE. The CFPB publishes a sample GFE and list of which fees can and can’t change.
In-House Lender: An “in-house” lender refers to where the mortgage application is processed, underwritten and closed in the same place.
The Scoop: When the company you applied with has all those pieces within their same company there is more control over the process and time needed to complete the loan, says Kelly. Often these lenders are also called “direct lenders” as opposed to a broker who sends the file out to another company to underwrite the loan.
Jumbo Loan: A jumbo loan is a mortgage loan above Fannie Mae and Freddie Mac’s conforming loan limits, currently $417,000 in most parts of the country, and $625,000 in some high-cost areas.
The Scoop: Jumbo loans are considered more risky to lenders, so they will typically carry slightly higher interest rates.
Loan-to-Value (LTV): The loan-to-value ratio compares the total amount of the loan to the value of the property. Figuring the LTV is easy: Just take the loan amount, divide it by the value and move the decimal two spaces to the right.
The Scoop: LTV is important for both purchase and refinance mortgage loans. High LTV loans are more risky. Some loan products or programs will not allow loans to be made above a certain LTV (for example, 80%), rates may be higher for higher LTV loans, or a lender may require the borrower to pay for mortgage insurance to protect the lender in case the borrower defaults.
Private Mortgage Insurance (PMI): If you are making a downpayment of less than 20% on a home or try to refinance and your LTV is above 80%, you may be required to pay for PMI, which protects the lender if you don’t pay back your loan.
The Scoop: You may be able to cancel private mortgage insurance after a period of time, if you pay down your balance to a certain amount or if the equity in your home increases.
PITI: The cost of principal, interest, taxes and insurance, calculated on a monthly basis.
The Scoop: Even if you plan to pay your taxes and insurance yourself, rather than let the lender collect and make those payments, your lender will calculate PITI and use it to compare monthly income to your monthly debt to see if the proposed payment is too high.
Points (Discount Points): One “point” equals one percent of the loan amount. On a $150,000 loan, for example, each point costs the borrower $1,500.
The Scoop: Discount points are used to reduce the interest rate; the more discount points you pay, the lower your interest rate. “On any given day there is a range of interest rates available with a corresponding cost (in discount points),” Kelly explains. ”On average, paying one point will provide an interest rate 1%-4% lower. Depending on your type of loan you may be able to pay more closing costs for a lower rate, or pay less for a slightly higher rate. Ask your loan officer for several options and compare which benefits you more.”
Servicer: Your loan may be “serviced” by a different company than the one from which you obtained your loan. The servicer collects payments, sends statements and manages disbursements such as payments for insurance or taxes loans with escrow accounts.
The Scoop: You don’t get to choose your servicer, and some do a better job than others. If you have a complaint about a servicer, you can share it with the Consumer Financial Protection Bureau.
VA Loans: Qualifying veterans can use these loans to purchase, refinance or improve homes. They allows borrowers to finance up to 100 percent of the VA-established reasonable value of the property. They carry a guarantee that helps protect the lender if the borrower defaults.
The Scoop: You’ll pay a non-refundable funding fee of 2.15% if you borrow the maximum amount available and this is your first VA loan, or 3.3% if this is your second VA loan and you are borrowing the maximum amount. For veterans who haven’t saved a large down payment, this can still be an excellent option. Kelly adds that, “Veterans who have any military disability can get the funding fee waived. If you are a veteran with a disability be sure to point this out to your lender to have this fee waived.”
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