14 Mortgage and Refinance Terms You Should Know
Starting the search for your first home? Thinking of refinancing to a better rate or a helpful cash out? Both can be exciting times, but there are likely to be bouts of anxiety during each process, too.
One tough part of homebuying or refinancing can be wrapping your head around a number of unfamiliar terms. Who or what is escrow and why do they have my money? What’s the difference between pre-approval and actual approval?
Fret not, as we’re here to help. While this is not an exhaustive list of unfamiliar words you may come across, these are 14 terms every homebuyer and those refinancing should know.
Amortization refers to the process of paying off debt over time in regular installments of interest and principal sufficient to repay the loan in full by its maturity date.
When making mortgage payments, some of that money goes toward the principal and some goes toward interest. The amount allocated toward interest and principal changes monthly, as more money goes toward the principal and less toward interest over time. Though that allocation changes, your monthly payment stays the same.
For example: Let’s say you got a fixed-rate 30-year loan and your monthly payments came out to $1,667. One monthly payment in the first year of your mortgage may allocate $1,300 to interest and $357 to principal. In year 10 of the loan, one monthly payment could be $1,050 to interest and $607 to principal. By the very end of the 30-year loan, your monthly payments would be down to a couple hundred dollars toward interest and the bulk toward principal.
Annual Percentage Rate (APR)
The APR is the more effective rate to consider when comparing loans. The APR includes not only the interest expense on the loan but also all fees and other costs involved in procuring the loan.
The APR is expressed as a percent. This is different than the note rate, which is the rate your monthly payments are based on. The APR is an important number to check as an inviting interest rate can become unappealing after weighing in fees and other costs.
This is the point at which your savings from a lower mortgage rate exceed the costs of refinancing. A good rule of thumb is to not refinance unless you plan to stay in your home long enough to hit the break-even point.
Closing Costs and Prepaids
As the name implies, closing costs is the amount it costs to close the deal. It includes costs such as title insurance, lender charges, escrow fees, real estate commissions, recording fees and more.
Prepaids are expenses you’ll have to pay at closing (before they’re actually due, hence the name) in order to obtain your mortgage. Prepaid expenses can include your first year of homeowners insurance, PMI, hazard insurance, a portion of property taxes, and more.
Though both are paid at closing, the key difference between the two is that closing costs are directly related to the real estate transaction while prepaids are related to the home itself. Be sure to consider both of these when budgeting for your new home, and shop around for the best rates as they can vary by vendor.
Escrow and Earnest Money
Escrow is a neutral third party that holds on to money for buyers and sellers.
Earnest money is a deposit that lets the seller know you’re serious about buying their home.
The earnest money doesn’t go straight to the seller, though; it’s held in escrow. Escrow can also come into play during other parts of the home buying process, such as during closing or when your lender pays your PITI (principal, interest, taxes and insurance) expenses.
Equity and Cash-Out Refinances
Equity is the difference between the current value of your home and how much you owe. So if your home is worth $200,000 and you owe $125,000, you have $75,000 equity in your home.
A popular way to tap into your home’s equity is with a cash-out refinance. This type of refinancing replaces your current mortgage with a new one that’s worth more than what you owe on the house. You then pocket the difference and can use the money toward home improvements, paying off bills, or other needs.
Cash-out amounts are limited to about 80%-90% of your home’s equity, so don’t plan on being able to get the full amount.
Debt-to-income ratio (DTI) is the amount of your current monthly debt divided by your total gross monthly income. It’s an important number to consider as you apply for a loan as it is used by lenders to assess risk. The higher your debt-to-income ratio, the tougher it’s going to be to get approved for a loan, as those with a high DTI ratio are seen as a risk.
Most lenders will want to see you at 36% or less DTI with 45% being the highest most will consider, though exceptions may be made in certain cases.
Origination fees are charged by the lender to cover the costs of processing your application and generally includes underwriting and funding the loan, an application fee and more.
We’re not about charging unnecessary fees here at Minute Mortgage, though. With the exception of rare cases, we don’t charge origination fees.
You can reduce your mortgage rate by paying more up front in the form of fees known as discount points. In other words, discount points are used to buy down the interest rate of the loan. One point costs 1% of the loan amount and each point bought will typically buy your rate down by a quarter of a percentage point.
For example: If you were approved for a loan at a rate of 4.5%, you could buy it down to 4.25% by purchasing one discount point. This is essentially prepaying interest, and spending several thousand dollars in discount points up front can potentially save you tens of thousands of dollars over the life of your mortgage.
If you’re not able to place a down payment of at least 20 percent, your lender may require you to purchase private mortgage insurance so they’re protected if you default on your loan. The amount you’ll have to pay for mortgage insurance is dependent on the amount of your down payment and your credit score. The cost is typically added to your monthly payment.
Being pre-approved means you officially know how much you can borrow. And your approval letter shows homebuyers you’re serious about buying and know how much you can afford. It’s best to get pre-approved early in the process as many real estate agents won’t agree to show you homes until you prove you’ve been pre-approved.
The process involves submitting a loan application, having your credit pulled and supplying the lender with documentation on income and assets needed to verify.
As mentioned, these aren’t likely to be all the unfamiliar terms you encounter during the loan process. If you’ve got questions on these or anything else related to your new or refinanced mortgage, contact the experts here at Minute Mortgage. Our team behind the tech is ready to help.