Mortgage Terminology 101

When you’re a first-time home buyer, you may encounter many new and sometimes confusing words and phrases relating to real estate transactions.

Even if you have a real estate professional assisting you, it’s important to familiarize yourself with the terminology so you can develop a better understanding of the home-buying process.

This list provides definitions of some of the most common mortgage-related terms that you need to know:

Adjustable-Rate Mortgage (ARM)

Also known as a variable-rate mortgage or floating rate mortgage, this type of loan has an interest rate that changes. An initial rate applies for a fixed amount of time, then changes annually; most set a cap on interest rates. A low initial interest rate, thus low monthly payments, make these loans ideal for those who plan to sell their home after only a few years and before the adjustable rate kicks in.

Affidavit of Title

A document provided by the seller of a piece of property that strictly states the status of potential legal issues involving a property or the seller. It is designed to protect a buyer from unresolved legal issues that the seller might face. If issues arise in the future, the buyer can use an affidavit of title in legal proceedings to defend themselves.

Amortization

The process of paying off or extinguishing a debt by means of a series of regular or fixed payments over a set period of time. In the case of paying off a home mortgage, it is the process by which the amount of your loan’s principal decreases over the life of the loan.

Assets

Property that you own that is considered to have value, particularly in the case of applying for a loan and which can be used as collateral for that loan.

Closing

In real estate, the final transaction between a buyer and seller in which the title to the property is transferred to the buyer and both parties review and sign off on the closing documents detailing the sale of the home, financing, title insurance, and associated closing costs. Also known as settlement.

Collateral

Typically a specific asset, such as a real property or personal property, used for securing a loan. For obtaining a mortgage loan, the home you wish to purchase is generally used as the collateral. Lenders will examine two values to determine a property’s collateral: the home’s sales price and its appraised value. The lender will use the lower of the two values, so if the property does not appraise to the sales price, then the lender must determine if the seller will lower the sales price or if the borrower is willing to pay the difference.

Construction-to-Permanent (C2P) Loan

A loan that shifts from a construction loan into a mortgage upon the completion of building a house. Homebuyers often go with this streamlined option because it contains only one approval and one closing.

Debt-to-Income Ratio (DTI)

The percentage of a person’s gross monthly income that goes towards basic living expenses and paying off debts. DTI is utilized by lenders to determine the risk associated with a person applying for a mortgage and whether or not the lender should extend an offer for a loan. For example, a person with a gross monthly income of $6,000 and monthly payments of $2,400 would have a DTI of 40. A DTI of 40 and lower is generally accepted by most lenders.

Delinquent Mortgage

A delinquent mortgage occurs when a borrower has failed to make payments on their home loan as promised. A lender can start foreclosure proceedings if a borrower cannot make payments on a delinquent mortgage within a certain period of time.

Earnest Money

A sum of money a homebuyer provides to the seller upon agreeing on a price as a show of good faith and intent to purchase the house. Usually, the earnest money is held in an escrow account until the sale is completed and then it becomes part of the buyer’s down payment. Earnest money can range from 1 percent to 3 percent of the purchase price, depending on the real estate market in your area.

Equity

The current market value of your home minus your remaining mortgage loan balance equals the amount of equity or “ownership” you have paid into your home. You build equity in your home over time as you pay down your mortgage and the market value of your home appreciates. Also known as home equity or homeowner’s equity.

Federal Housing Administration (FHA)

Part of the U.S. Department of Housing and Urban Development (HUD), the FHA offers home loans featuring low down payments, low closing costs and easy credit qualifying terms.

FHA Loan

A mortgage insured by the FHA that protects a lender if the borrower defaults on the loan. FHA loans normally have lower interest rates.

Fixed-Interest Mortgage

A fixed-rate mortgage is a fully amortizing mortgage loan where the interest rate on the note remains the same through the term of the loan. This type of loan is different to loans where the interest rate may adjust or “float.” Payment amounts and the duration of the loan are fixed. Those who take this kind of loan benefit from a consistent, single payment and the ability to plan a budget based on this fixed cost.

Good Faith Estimate (GFE)

This document outlines the terms and required costs associated with your mortgage loan, including lenders’ fees, loan interest rate, points, title and transfer fees, and insurance. Lenders are required to provide a GFE to all mortgage loan applicants within three business days of the application unless the application is turned down.

HUD-1 Settlement Statement

This form from the U.S. Department of Housing and Urban Development (HUD) is required by the department to be used as a statement itemizing all of the actual costs and adjustments for each party (buyer and seller) in a real estate transaction. These costs include the cost of the property, loan fees, title insurance, home insurance, real estate agent commissions and attorney’s fees. The statement is generally prepared by a closing agent, who then provides each party with a copy of the statement for review one day prior to the actual closing or settlement. Also called a closing statement.

Lien

A legal claim placed by a creditor on a piece of real property that allows the lien holder to receive a specified amount of money upon sale of the property to satisfy the debt. The property often serves as collateral against the amount owed. In some states, a home mortgage can be considered as a lien, instead of a complete transfer of title.

Interest-Only Loan

A type of loan in which monthly payments consist only of interest for a set period, usually five to 10 years. After this period, the mortgagor has the option to refinance, pay off the principal in full or begin making incremental payments on the principal.

Mortgage

A legal agreement in which the conditional right of ownership of a home is conveyed by the borrower (mortgagor) to the lender (mortgagee) as security or collateral for the loan to purchase the home. If you, as the borrower, don’t pay the loan, the lender can foreclose on your home.

Non-Compete Clause (NCC)

A legal agreement in which one party agrees not to enter into business with a competing entity, start a competing entity, or otherwise reveal the confidential information of another party. An NCC is usually a contract made between an employee and an employer designed to protect a company from having their trade secrets or other confidential information exploited. Also known as a covenant not to compete (CNC).

Preapproved

The buyer’s stated income, asset information and credit score have been evaluated and verified by the lender to ensure the buyer qualifies to purchase a home at a particular loan amount. The preapproval process takes approximately 7 to 10 business days, but once a buyer is preapproved, the buyer can close on the actual purchase more quickly. This is especially important in a strong real estate market where available houses can sell quickly.

Prepaids

Refers to the items or costs that are required by your lender to be paid in advance at closing to protect the home loan. These items, which include your home insurance premium (from several months up to one year’s premium), property taxes and private mortgage insurance (if applicable), are paid into an escrow account from which the lender can directly pay the insurance company or property tax collector. Prepaids should not be confused with other closing costs that are connected to the loan itself, such as lender’s fees, title charges or attorney’s fees.

P&I (Principal and Interest)

The two primary components of a monthly home mortgage loan payment. Principal is the amount that goes toward paying down the loan’s balance, while interest is the amount that you as the borrower pay to the lender for the loan. Also called PITI (principal, interest, taxes, insurance), which includes the other components of your payment: your property taxes and home and mortgage insurance.

Points

Fees paid to the lender for the loan, usually at closing, to receive a lower interest rate, and thus, lower monthly payments. One point equals 1 percent of the loan amount for your mortgage. This process of “buying points” can be beneficial if you plan to stay in your home for an extended time. Also known as discount points.

Sales Contract

A legal agreement between the buyer and the seller regarding the terms of purchase of a piece of residential property. For new construction homes, a house may be considered sold upon signing of the sales contract by the homebuyer and the builder’s representative, although the actual structure will not be completed for several months. Also called contract of sale or sale and purchase agreement.

Short Sale

A real estate transaction in which the proceeds from the sale are less than the amount needed to pay off the remaining mortgage debt. An alternative to foreclosure, a short sale occurs when the lender and the borrower agree to take a loss on the property instead of the borrower completely defaulting on the loan.

Single-Close Financing

A type of home loan in which a buyer assumes responsibility for the financing of construction at the onset of building that later converts to permanent financing once construction is complete. A buyer can typically attain this type of financing at a cheaper rate than a builder, thus bringing down the overall cost of construction. Other advantages to single-close financing include only paying one set of closing costs, fixed interest-only payments during construction (up to 12 months), no prepayment penalties and the chance to assume occupancy immediately at the conclusion of construction. Downsides to this type of loan include assuming the risk that the home will be well-built and no chance to back out. Also known as a one-close loan, construction-to-permanent loan or C2P loan.

Title

A legal document listing the right to ownership and possession of a house or other piece of real property. The title is registered as public record.

Underwater Mortgage

A mortgage is considered underwater if the price of someone’s mortgage is more than the market value of your home. If someone wants to sell their home, they would have to pay out of pocket the difference between the mortgage and the final selling price.

VA Loan

A VA loan is a mortgage loan guaranteed by the U.S. Department of Veterans Affairs (VA) that offers help with long-term financing to eligible American veterans or their surviving spouses. The VA home loan program supplies home financing to veterans to help them purchase properties with no down payment. Eligible areas for these homes are designated by the VA as housing credit shortage areas, which are generally rural areas and small cities.