Are you are actively looking to buy a home in the near future? It pays to educate yourself as much as possible. Your real estate agent and mortgage advisor may throw around words, phrases, and abbreviations that are as familiar to you as astrophysics, making you uncomfortable and unsure.
Here are seven common mortgage terms you will undoubtedly hear on your path to home ownership, what they mean, and how they affect your chances of landing a mortgage loan.
1. LTV Ratio
There are a variety of ratios lenders use in their loan decisions, one being the Loan-to-value (LTV) ratio. This takes the amount of the loan and the home's actual total value. For example, if you're buying a $180,000 home, and have a $40,000 down payment, your loan amount would be $140,000. Your LTV ratio is roughly 78%. Fannie Mae offers a simple calculator to help figure this out.
What this means for you: Ideally, the lower your LTV ratio, the better. A high, over 80% LTV ratio narrows your loan choices, and, in some cases, completely eliminates your chances of qualifying for a mortgage. This is why a substantial down payment is essential.
Once you decide on a home, the lender will order an appraisal on the property. This report shows how much the house is worth, in relation to its size, location, and recent sales in its proximity.
What this means for you: If the house appraises for lower than the price you have agreed on with the seller, it can decrease the chance the bank will lend you the amount of money you need. At this point you will either need to bring more cash to closing to cover the difference, or the deal will derail.
Your mortgage originator may talk to you about "paying down points." A point is the term referencing 1% of the mortgage amount. If, for example, your mortgage loan will be $100000, a point is $1000.
Paying down points lowers the interest rate you pay on the mortgage over the life of the loan. It is generally negotiated between the buyer and seller as to which party will pay down points.
What this means for you: Paying down points decreases your monthly payment. Several questions, such as how long you plan to stay in the home, the monthly payment you can reasonably afford, and your access to the cash to pay down points, will help decide if paying down points is worth it to you.
You want the underwriter to be your friend, as he, she, or it decides whether or not you qualify for your mortgage loan.
An underwriter may be a person, or it may be an automated system. Either way, the underwriter analyzes all pieces of your financial information, the home's selling price, and appraisal, and determines whether or not the lender will extend a loan.
What this means to you: The underwriter can make or break your home buying pursuit. Take great pains to submit all requested information in a timely manner. This includes pay stubs, financial records, proof of employment, and anything else the mortgage originator requests on behalf of the underwriter.
5. Credit Score
While most people know about credit scores, it's vital to revisit your credit report before purchasing a home. Strict rules govern required scores for mortgage qualification.
What this means to you: Put top priority on paying your debts on time and paying down debt. In addition, t's estimated one in four credit reports contain errors. Order a free copy of your credit report, review it carefully, identity any incorrect information or accounts you don't recognize, and dispute any erroneous information.
6. Amortization Schedule
As you make monthly payments, you also pay interest on the loan. Over time, the amount of interest for each payment decreases, and the amount of payment on the actual loan increases.
What this means to you: While your payment is the same, you pay the majority of the loan's interest in the first few years of the loan. It is advantageous, if your budget allows, to pay extra on the principal. This will decrease the amount of interest you ultimately pay.
Private Mortgage Insurance (PMI) is required when you borrow over 80% of the home's value. PMI protects the lender in the event you don't fill the terms of the loan. PMI is fairly expensive, and adds significantly to your monthly mortgage payment. The good news is, once the loan is paid down to under 80% of the home's worth, you can "get out from under" PMI, and/or refinance.
What this means to you: Try to avoid PMI by saving a comfortable down payment so that you need to borrow 80% or less of the home's appraised worth.
Buying a home is one of life's biggest decisions, so be as prepared as possible. Understanding these terms, and conducting your own research, will assist in preparing you for the decision and subsequent process of securing a mortgage loan.