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By Jamie Smith
Using a mortgage to buy a home can be a complex process, and there are many different factors you should consider. Before you start applying for mortgages, you should learn some basic mortgage terminology. Here are some of the most common mortgage terms and their definitions.
Amortization is the process of paying off a loan, like a mortgage, over time. Each payment is the same amount. Part of each one goes toward the principal, or the amount you borrowed, and part goes toward interest, which is the amount you pay to the lender in exchange for borrowing the money. As the principal decreases, the amount of each payment allocated toward interest decreases as well. When you start paying down a mortgage, most of each payment goes toward interest. During the last years of the loan, most of your paymentmoney helps reduce the principal instead.
When a loan fully amortizes, it means you have made every payment according to the original schedule on your term loan and you have made every payment. For example, the amortization term for a 15-year, fixed-rate mortgage is 180 months. An amortization schedule or table tells you how much of each payment will go towards interest and principal.
An adjustable-rate mortgage (ARM), also called a variable-rate mortgage, has a low initial interest rate that can increase after an introductory period. After that period ends, the rate fluctuates based on the current market rates. It can help you save money if you plan to sell before the interest rate increases, and many people can afford to borrow more with an ARM than they would with a traditional mortgage. However, you should be prepared for an eventual increase in your payments and interest rate. If you can't afford the increased payments, you risk ultimately being forced to sell the home or become vulnerable to foreclosure.
Most ARMs have a rate cap that limits the interest rate or an adjustment cap that restricts how much the rate can increase or decrease. The adjustment date is the date when the interest rate increases, and an adjustment period is the amount of time between multiple adjustment dates.
The annual percentage rate (APR) includes a mortgage's interest rate and any other charges or fees such as mortgage insurance, most closing costs, discount points and loan origination fees that you pay for the loan. It's a percentage of the principal. For example, someone with a mortgage APR of 3.5% and $100,000 in principal would pay $3,500 in interest for one year. That's about $290 per month. Considering the APR is better for gauging the costs of a mortgage than only looking at the interest rate.
A balloon payment is a larger-than-usual one-time payment at the end of the loan term. If you have a mortgage with a balloon payment, your payments may be lower in the years before the balloon payment comes due, but you could owe a big amount at the end of the loan
A closing disclosure provides details about the mortgage loan you select. It contains loan terms, projected monthly payments, and closing costs. Closing costs can include mortgage-origination fees, appraisal fees, title-search fees, and more. Buyers pay closing costs in most transactions, but the seller may cover some of these expenses.
Your debt-to-income (DTI) ratio measures your ability to repay a mortgage. It's the ratio of all your monthly debts divided by your gross monthly income. Many lenders look for borrowers with a DTI ratio of 43% or less. That means someone who makes $10,000 per month should usually have less than $4,300 in monthly debts to get the best interest rates.
Earnest money is a deposit that a buyer makes when they agree to purchase a home. The title company usually holds earnest money in an escrow account, also called an impound account. An escrow account often holds the part of each monthly mortgage payment meant for homeowner's insurance premiums and property taxes as well.
After closing, earnest money goes toward the closing costs or the down payment. If the contract is terminated for a permissible reason, the earnest money is returned to the buyer. If the buyer does not perform in good faith, the earnest money mat be forfeited and paid out to the seller.
The loan-to-value (LTV) ratio compares the amount you owe on your mortgage to your property value. An LTV ratio of 80% or less when starting a mortgage is ideal. That means you would make a down payment of 20%. Many lenders permit lower LTV ratios and down payments, and you can even find mortgages with no down payments. For example, the Alliant Advantage Mortgage program has low down payment options, as low as 0% down for first-time homebuyers.
Private mortgage insurance (PMI) protects the lender if you stop making payments on time. Many lenders require PMI if you put less than 20% down of the property value. After you have 20% or more equity in your home, you may be able to cancel PMI. Most PMI payments are combined with the monthly mortgage payment. With some lenders, you can also choose an up-front, one-time premium payment or a combination of both options. If you move or refinance and you make an up-front payment, you may not get a refund for your PMI.
A mortgage prequalification from a lender is an estimate of the amount you can afford to pay for a mortgage. It's based on the information you provide about your credit score, income, assets, and debts. Getting prequalified can make shopping for a home easier by helping you avoid looking at places that you can’t afford.
Mortgage preapproval includes a detailed credit check of your finances-your income, debt, assets and credit history to determine how much money you can borrow. Lenders usually require tax returns, copies of bank statements, and recent pay stubs. Alliant actually completes a credit check during prequalification, letting you get a more accurate idea of what you can afford and finish the preapproval process quickly when you're ready.
Fannie Mae and Freddie Mac are nicknames for the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). These organizations own or guarantee most mortgages and home loans in the United States. However, they don't guarantee loans over a maximum limit called the conforming loan limit. A nonconforming loan doesn't meet Fannie Mae and Freddie Mac guidelines, and it may not meet DTI ratio guidelines and other requirements. These mortgages usually have higher rates than conforming loans.
Understanding these mortgage terms can help you choose the best loan for your needs and help you feel confident and prepared when you begin the homebuying process.
Looking for the perfect home? Alliant has mortgage loan options to fit any budget.
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