Annual percentage rate

Ever notice that mortgage ads have two sets of numbers? These are the interest rate and the annual percentage rate (APR) — and knowing the difference is crucial.

The APR represents the true cost of your credit: interest plus fees and any other one-time costs associated with the loan. Since different lenders have different interest rates and costs, the APR helps you compare apples to apples, mortgage-wise.

Here’s one example of APR calculation:

You plan to borrow $100,000 at 4.5% interest, which would result in a monthly payment of $506.69. However, the loan carries $900 in fees and you also decide to buy one point (more on that below) for $1,000. Now the loan would be $101,900, resulting in a monthly payment of $516.31.

To calculate the APR, go back to the original loan amount of $100,000 and figure the interest that would have made for a monthly payment of $516.31. The result: You may have taken out the loan at 4.5% interest, but you wound up paying an APR of 4.661%.

A lender’s interest rate may look inviting, but its fees and other costs could change the game. Pay attention to the APR. The law requires that all ads include it.

Earnest money

This is the money you give to show you’re serious about this purchase. Earnest money is generally 3% to 5% of the home’s cost.

The money goes into an escrow account until financing is arranged; at that point, it gets credited to the purchase price. If the sale doesn’t go through, the seller generally gets to keep the money.

Closing costs

Also known as settlement costs, this is the amount of money you need to close the mortgage deal. Closing costs could include title insurance, escrow fees, lender charges, real estate commissions, transfer taxes and recording fees.

Origination fee. Those lender charges may include the cost of processing your mortgage application and underwriting and funding the loan, among other things. Known as an origination fee, it can be as much as 1% to 6% of the loan amount. This can have a particularly noticeable impact on a larger mortgage.

All closing costs will be listed on the loan estimate that the mortgage lender gives you within three business days of your application.

You can expect to pay between 2% to 5% of the purchase price in total closing costs, which isn’t chicken feed: On a $200,000 loan that would mean paying an extra $4,000 to $10,000. It’s possible to shop around for some of these fees, cutting costs by at least a few hundred dollars.

 

Points

When you buy points, you’re paying more upfront in exchange for a lower interest rate, which means you pay less over time. Each point equals 1% of the mortgage.

How much your interest rate gets lowered depends on the type of loan, the individual lender’s policies and the mortgage market at the time. Points can be a good idea if you believe you’ll keep the mortgage long enough to make back the cost.

Equity

This is the difference between what you owe on your home and the market value of that home. Equity builds as you pay down the mortgage. It might also grow if home values in your region change noticeably.

You can tap this value over time, in the form of a home equity loan, a home equity line of credit or a 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.

If the mortgage you choose doesn’t require an escrow account, the Consumer Financial Protection Bureau (CFPB) suggests you ask for one. Paying as you go makes it easier to budget for these expenses, rather than coming up with the money for the tax bill or insurance premium all at once.

Rate lock

Because of the changeable nature of interest rates, some homebuyers opt for a rate lock. Also known as a lock-in, this is a guarantee that the interest rate won’t change between the day you make your offer and the day you close on the home (provided there are no changes to your mortgage application).

Generally the rate lock period runs from 30 to 60 days, although it can be longer. If interest rates are fluctuating noticeably, locking in a rate can save you money.

However, the CFPB notes two potential downsides:

  • If you lock in and interest rates fall, you’re stuck with the higher rate.
  • If closing takes longer than expected, extending the rate lock can be costly.

In addition, your rate might still change if your application alters. Some common reasons are a change in your credit score, the home appraisal being higher or lower than expected, and the choice to take out a different kind of loan or make a different down payment.

Loan estimate

In the past, lenders gave applicants something called a “good faith estimate,” which listed settlement charges and mortgage terms. As of October 2015, the CFPB instituted a new version called a “loan estimate.” Part of the CFPB’s “Know Before You Owe” program, the loan estimate is a simpler way for consumers to understand the total cost of a mortgage and to shop for the best loans.

Lenders have three business days to provide the loan estimate to applicants. Among other things, it explains the specified loan amount, interest rate (including the APR), estimated monthly payments, estimated assessments, insurance and taxes, and the estimated cash needed at closing.

 

 


Connect with a Loan Officer

Loan Officer Thomas Johnston

Loan Officer Thomas Johnston | NMLS# 1583463; Arizona, California, Oregon, Texas and Washington

Thomas is your mortgage loan originator, who works side by side with a strong team that shares the same devotion to excellence.
Experienced, knowledgeable, and always up to date on the industry's latest products, Thomas strives to exceed the customers' expectations in each and every transaction.

Do you have any questions? Please call 866-610-6025


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.

Here’s an example:

  • A $200,000 mortgage at 5% interest would carry a monthly payment of $1,073.64. The first month, $833.33 would go to interest and only $240.31 to principal.
  • Now, the loan balance is $199,759.69, so the next month the 5% interest payment would be slightly lower: $832.33. As time goes by, more of each monthly payment goes toward principal.

It can be frustrating to have so much of your early payments going toward interest rather than toward paying off the principal. A few possible workarounds:

Make a bigger down payment. The smaller the loan, the less interest you’ll pay. Bonus: If you can put down 20% or more then you won’t have to pay for private mortgage insurance. 

Make extra payments. Again, the smaller your loan balance, the less interest you’ll pay. Make sure your mortgage doesn’t have a prepayment penalty and also that the extra payments are credited toward the principal.

Choose a shorter loan. By choosing a 15-year mortgage over a 30-year mortgage, your payments will be larger, but you’ll save a ton over the life of the loan. Bonus: Taking a shorter loan term might get you a better interest rate.

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.

If an underwriter denies the loan, you should ask why. A lender must give a written explanation if you request one within 60 days.

If you were rejected based on credit score, the lender must give you:

  • Material about your right to get a free credit report within 60 days of the notice.
  • Contact information for the credit reporting bureau.
  • An explanation of how to fix credit report mistakes or how to make the report more complete.
  • The credit score it used, plus the main factors that affected the score.

If you obtain the credit report and find inaccurate material in it, you can dispute the information.

 

 

Preapproval, pre-qualification

These terms are sometimes used interchangeably, so what they actually mean depends on your lender.

“Pre-qualification” might mean you have given some basic information (income, debts, anticipated down payment) and signaled your desire for a mortgage, without submitting any actual documentation. “Preapproval” might mean that the lender has checked you out more thoroughly, from your credit score to your job history.

However, some lenders use their own terms, such as “credit-only approval,” and the CFPB uses “preapproval” as a catchall term.

On its website, the CFPB suggests that people not worry about the semantics. “The important thing is that the letter you receive provides enough information for sellers in your area to take it seriously,” the agency notes.

Being preapproved lets sellers know you mean business. In a tight housing market this could give you an edge over other potential homeowners because you are prepared to make a bid.

Getting preapproved will have a small negative impact on your credit score. However, if you complete several mortgage applications within 14 to 45 days it won’t be too bad, since multiple inquiries will add up to one hard credit pull.

It’s a good idea to look for mortgage quotes before applying to a lender, to get some idea of what to expect. 

Mortgage insurance

In the case of default, mortgage insurance protects the lender. Generally it’s required for borrowers who put down less than 20%.

In government-backed mortgages, mortgage insurance takes several forms:

  • Veterans with VA loans usually pay a one-time fee at closing.
  • With Federal Housing Administration (FHA) loans, borrowers pay an upfront fee and an annual premium.
  • For U.S. Department of Agriculture (USDA) mortgages, borrowers also pay money upfront plus an ongoing premium.

For conventional (non-government) mortgages, coverage is provided by private insurers and is known as private mortgage insurance (PMI). The cost amounts to another 0.15% to 1.95% on your mortgage each month. After you reach 20% equity in your home, you can request that PMI be canceled.

Principal

The principal is the amount you borrowed. A portion of each mortgage payment goes toward principal and another portion goes toward the interest.

As you pay down the principal, your equity in the home grows. It is possible to make extra payments toward the mortgage principal. Doing so will reduce the amount of interest you pay over the life of the loan.

Rate

Expressed as a percentage, this is the cost you pay to borrow money. It does not include any other charges associated with the mortgage loan.

The interest rate you receive is influenced by multiple factors, including, but not limited to, your credit score, the type and length of the loan, the down payment and the price of the home.

Rates might change from day to day, or even from hour to hour. 

 

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 homebuyers to have lender’s title insurance. Having owner’s title insurance protects you against future claims.

Costs vary from state to state. It could be possible to get a better rate by purchasing both types from the same insurance company.

 

In Conclusion 

These are just some of the common mortgage terms you’ll need to know when shopping for a home. It may seem daunting at first, but it doesn’t need to be. Instead, think of the process as a visit to a new country. Learning a few phrases in the new language will help you get around, and also give you the confidence to pick up more of the lingo.

It’s the same with homebuying: As you learn common mortgage terms, you’ll be better prepared to explore the territory. Everything you learn will position you to make the best choices for your finances and your future.


Connect with a Loan Officer

Loan Officer Thomas Johnston

Loan Officer Thomas Johnston | NMLS# 1583463; Arizona, California, Oregon, Texas and Washington

Thomas is your mortgage loan originator, who works side by side with a strong team that shares the same devotion to excellence.
Experienced, knowledgeable, and always up to date on the industry's latest products, Thomas strives to exceed the customers' expectations in each and every transaction.

Do you have any questions? Please call 866-610-6025

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