Lending Terminology You Should Know

With buying a home, also comes choosing a mortgage. The process of searching for and acquiring a mortgage can be stressful, especially when there are many complicated terms involved. Being equipped with an understanding of common terminology in lending can aid in making this process less stressful. Below are some of the most common terminology you may encounter throughout the lending process.

Terminology

Lending Terminology
  • Adjustable-Rate Mortgage (ARM): This is a type of loan where the interest rate fluctuates every month. As a result, monthly payments will change depending on factors such as the loan’s introductory period, rate caps, and the index interest rate. The interest rate and the payment for an ARM can start lower than a fixed mortgage, however, both the rate and payment for an ARM can substantially increase over time. 

 

  • Amortization: Amortization is paying off a portion of the loan each month so that the overall loan amount is decreased over time. Home loans typically amortize, however, there are instances where the full loan amount is not paid off after completing all payments. This instance can occur when a loan only allows payments to cover the amount of the interest, or even less. It is important to research if a loan is fully amortized before choosing it. 

 

  • Annual Percentage Rate (APR): This rate is a more broad measure of the interest rate, and considers multiple factors that calculate the cost of borrowing, including the interest rate, broker fees, and additional charges required for securing the loan. For this reason, the APR is typically a higher number than the interest rate. 

 

  • Appraisal Fee: This fee covers the cost of the home appraisal, which is used to determine the home’s value. Appraisals are independent assessments of home value and are usually conducted by the mortgage lender’s choice of the appraiser. 

 

  • Closing Costs: These are costs that are paid to the lender in exchange for loan finalization during the home closing process. Specific fees depend on the type of property and its location, but common costs include appraisal fees and loan origination fees. In most cases, closing costs are approximately 3-6% of the loan amount. 

 

  • Closing Disclosure: This is a multi-page document that outlines the final details of the loan. The closing disclosure lists the loan terms, including the interest rate, loan principal, monthly payments, and closing costs. 

 

  • Down Payment: This payment is the amount of the loan that is paid upfront, and is a percentage of the home’s value. A down payment is required to be approved for a loan. Typically, the higher the down payment that is made, the lower the interest rate that is received in return. 

 

  • Escrow: An escrow is an account set up by mortgage lenders that holds money for property taxes or homeowner’s insurance. This allows for payments for taxes and insurance to be made along with the monthly payment, instead of all at once. 

 

  • Fixed-Rate Mortgage: This is a type of loan where the interest rate remains constant throughout the entire term of the loan. For example, if a 15-year loan has an interest rate of 5%, the monthly interest will remain 5% for the entire fifteen years.  Homeowners who choose a fixed-rate mortgage feel it allows them more stability without the worry that the interest rate may suddenly increase; this type of loan also allows for predictability during financial planning.  

 

  • Interest Rate: The interest rate is a percentage of the loan that is required to be paid monthly in exchange for borrowing the money. For example, if the interest rate is 4% on a loan of $100,000, the amount of interest to be paid monthly is $4,000. 

 

  • Mortgage Term: The mortgage term is the number of years needed to fully repay the loan and gain full ownership of the home. Most loans are offered as 15-year or 30-year, however, there are few instances in which lenders offer terms as short as eight years. 

 

  • Pre Approval: This is a document that details how much a homeowner can afford to take out on a loan, and is considered the first step of the mortgage process. When applying for pre-approval, the lender will require financial information such as credit score, income, and total assets. All of this information will be used to determine the qualifying loan amount, which can be incorporated into a budget when searching for homes. It is important to note that pre-approval is not the same as pre-qualification.

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