Mortgage 101
If you've never applied for a mortgage, you will find it helpful to learn a few basic terms about the mortgage application process. We've provided a summary of some key mortgage terms below.
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Key Mortgage Terms
- Annual Percentage Rate (APR) – The annual percentage rate is an “effective” interest rate that the government has created to help consumers compare loans. The APR is higher than the interest rate because it includes the interest and other fees and costs associated with a loan. For a mortgage, the APR can include the loan origination fee, points, and mortgage insurance premium.
- Appraisal – A lender will order an appraisal after a borrower’s offer to purchase has been accepted. Typically the appraisal costs $300 to $500 and is paid for by the borrower. In this part of the mortgage process a licensed appraiser will tour the home and use objective market data to render a professional opinion on the home’s value. This due diligence helps ensure the borrower is purchasing a home at a fair market price. It also protects the lender by ensuring the lender is not financing an amount that is higher than what the home is worth.
- Adjustable Rate Mortgage (ARM) – An adjustable rate mortgage includes both a fixed and adjustable rate component. Monthly payments begin with an interest rate that is fixed for a short period of time. After the fixed rate period is over, the loan switches to the variable rate component. A “5/1 ARM” is a common type of adjustable rate mortgage. This refers to a loan whose rate is fixed for the first five years of the loan. Then the mortgage switches to a variable rate which is adjusted annually based on the market index used by the loan.
- Fixed Rate Mortgage – A fixed rate mortgage provides borrowers with a total monthly principal and interest payment that is the same throughout the duration of the loan. This type of loan provides borrowers with predictability and stability, by allowing borrowers to budget for the same mortgage payment each month. Your lender can help you think through whether a fixed rate or adjustable rate mortgage is best for you.
- Points – Points are fees that are collected from the borrower so that the borrower may “buy down” her interest rate. A borrower might choose to do this in order to take advantage of a lower rate over the course of her loan. Talk to your lender about the costs, benefits, and break-even point of a mortgage rate buy down.
- Private Mortgage Insurance (PMI) – Private mortgage insurance protects the lender in the event that the borrower defaults on the loan. PMI is an insurance premium that is added on to the borrower’s monthly mortgage payment. Most lenders require private mortgage insurance for home buyers who have less than a 20% down payment on their mortgage.
- Rate Lock-In – Interest rates can fluctuate daily. However, once a borrower has an accepted offer, the borrower can “lock-in” the interest rate and points for her loan. This protects the borrower against interest rate increases that occur prior to closing. Typically there are limitations on the number of times a borrower can “lock–in” a rate. Be sure you speak to your lender and learn the nuances of the rate lock process.
Ready to get started with your home loan? Learn more about the mortgage pre-approval process here.