Amortization, earest money, & principal, oh my!

The Breakdown

The mortgage industry has a lot of big words and fancy acronyms. It’s important to understand everything that we’re discussing because, well, it’s your money we’re talking about. Here are the A-Z’s of the mortgage industry.

AMORTIZATION: With each mortgage payment, some of the money reduces the loan balance and some pays interest. This allocation is called amortization. While the earliest payments mostly cover interest, the split changes over time. That’s because as the loan gets smaller, less interest gets charged.

ANNUAL PERCENTAGE RATE (APR): There are two sets of numbers to pay attention to when looking at a mortgage, the interest rate and Annual Percentage Rate (APR). APR includes the interest with any other fees included.

APPRAISAL OR APPRAISED VALUE: An expert estimate of the value of a property. Used during buying, selling, or refinancing a property.

CLOSING COSTS: Closing Costs is the amount of money you need to close the deal. These costs could include title insurance, escrow fees, lender charges, real estate commissions, transfer taxes, recording fees, & origination fees.

COMPARABLES (COMPS): Properties similar to the property under consideration for a mortgage that are approximately the same size, with similar location and amenities that have recently been sold.

CONFORMING LOAN: A mortgage that has the standard features as defined by Fannie Mae and Freddie Mac.

CONTINGENCY: A specified condition in a sales contract that must be satisfied before the home sale can occur. The two most common contingencies are that the house must pass inspection and the borrower must get approved for the loan.

CREDIT REPORT: A record of a person’s debts and payment habits used to determine whether or not a potential borrower is a good business risk.

CREDIT SCORE: A number that rates the quality of a person’s credit.

DEBT TO INCOME (DTI): Debt to income ratio is the amount of monthly obligations reported on a credit report compared to your monthly income. Simply take your total debt figure and divide it by your income. For instance, if your debt costs $2,000 per month and your monthly income equals $6,000, your DTI is $2,000 ÷ $6,000, or 33 percent.

DEFAULT: Failure to make mortgage payments on time or to meet other terms of a loan. Default can lead to foreclosure.

DOWN PAYMENT: The amount of cash you pay toward the purchase of your home to make up the difference between the purchase price and your mortgage loan.

EARNEST MONEY: This is the money you give the seller to show you’re serious about the purchase. It’s usually 3-5% of the cost of the home. The money goes into escrow until financing is arrange and will be credited towards the purchase price. If the buyer backs out, the seller generally gets to keep the money.

EQUITY: This is the difference between what you own on your home and the market value of that home. Equity builds as you pay down the mortgage. You can also tap into the equity in the form of a home equity loan or reverse mortgage.

ESCROW: In a real estate transaction, a neutral third party called escrow handles money for buyers and sellers. If you put down earnest money, for example, it goes into escrow until the purchase is complete. Another example of escrow is the account your lender sets up for homeowners insurance and property taxes. A portion of each mortgage payment goes into the account.

LOAN TO VALUE (LTV): The remaining loan amount compared to the home value. This is shown as Loan Amount divided by Purchase Price (Value). For instance, if your loan amount is $320,000 and your value equals $400,000, your LTV is $320,000 ÷ $400,000, or 80 percent.

MORTGAGE INSURANCE: In the case of default, mortgage insurance protects the lender. Generally it’s required for borrowers who put down less than 20%. There are three main types:

(1) LENDER PAID (LMPI): An option for conventional loans only. The mortgage insurance is paid through the rate. This results in an overall lower payment because there is not a separate mortgage insurance payment. LPMI has an overall lower payment than the other options, but because it is built into the rate, it can not be removed.

(2) MONTHLY MORTGAGE INSURANCE: The mortgage insurance is paid monthly and is included in the overall payment (PITI). The monthly fee will automatically drop when the loan goes to 78% Loan to Value (LTV). This is calculated based on the original balance of the loan, and may take a few years to accomplish. This is true for conventional loans. All government loans require some sort of monthly mortgage insurance.

(3) SINGLE PAID PREMIUM: A lump sum of money can be paid to the mortgage insurance company to avoid a monthly payment. This is paid at closing. This option is available for conventional loans and does not apply to government loans.

PRE-APPROVAL: Obtaining pre-approval means that the lender has checked out your income, debts, anticipated down payment, credit score, job history, etc. and will provide a letter that you are qualified up to a certain amount. This can help in a buying situation because it lets sellers know that you’re serious.

PRINCIPAL: The principal is the amount you borrowed. A portion of each mortgage payment goes to principal and another portion goes to interest. As you pay down the principal, your equity in the home grows. You can make extra payments directly to principal to help pay less interest over the life of the loan.

RATE: This is the cost (in percentage) you pay to borrow the money. It does not include any other charges associated with the loan. Interest rate is influences by factors such as credit score, type, loan length, down payment, and price of home.

RATE LOCK: Because of the changeable nature of interest rates, some home buyers opt for a rate lock. This means that the interest rate won’t change between the day you make your offer and the day you close on the home. Generally the rate lock period runs from 30 to 60 days.

RECORDING: Charge for a public official (typically a Registrar of Deeds or County Clerk) noting in the public record the terms of a legal document affecting title to real property such as a deed, a security instrument, a satisfaction of mortgage or an extension of mortgage.

SELLER CONCESSIONS: In a purchase transaction, it is very common for the seller to accept and pay for the buyer’s closing costs.

TITLE COMPANY: The agency that will investigate a property’s title (or deed) for discrepancies or undiscovered liens and that will issue title insurance to the lender after the title is deemed clear.

TITLE INSURANCE: Two types of title insurance exist: lender and owner. Both guard against any disputes about the title, such as tax or contractor liens. Lenders usually require home buyers to have lender’s title insurance. Having owner’s title insurance protects you against future claims.

UNDERWRITER: The person who approves or denies a home loan, based on the lender’s underwriting and approval criteria.

UNDERWRITING: This is the review of your loan application to see if it should be approved. Underwriting is part of the lender’s origination fee. Among other things, it takes into account your credit history, income, assets and liabilities and the appraisal of the home you want to buy. Based on the underwriter’s findings, the loan will be approved or denied.