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Securing a mortgage can be confusing. In fact, 15% of buyers say that understanding the process is the most difficult part of the homebuying journey, according to a recent National Association of Realtors survey. Lenders and real estate agents tend to throw around a lot of jargon—and if you aren't in the know, it can feel overwhelming.
Here are 19 common mortgage terms to help you feel more confident when buying a home.
19 Important Mortgage Terms to Know
Mortgage: This is the loan used to buy a home. You repay the mortgage over a predetermined period of time, typically 15 or 30 years. The lender will hold the deed until that time. The property secures a mortgage loan, which means your lender can repossess it by way of foreclosure if you default.
Credit report: Mortgage lenders will review one or more of your credit reports, which keep a record of your account balances, total debt, age of your credit accounts, payment history and other information. Credit reports give lenders a sense of how well you've historically managed your accounts, which helps them predict how likely you would be to default on a home loan. You can view your Experian credit report for free.
Credit score: The information on your credit reports determines your credit scores. Higher scores suggest you're capable of handling your credit responsibly, while lower scores may indicate that you're a risky borrower. Mortgage lenders typically use specialized FICO® Scores☉ . The minimum score for a conventional mortgage is around 620, though you may qualify for an FHA mortgage with a score as low as 500.
Down payment: This is the money you contribute upfront toward your home purchase. Mortgage lenders generally require a substantial down payment to demonstrate that you're financially healthy and invested in the purchase. This amount is due upon completion of the closing paperwork for your mortgage, and your loan makes up the rest of the purchase price (plus interest). While a 20% down payment was once the norm, it's possible to buy a home with much less.
Interest rate: Expressed as a percentage, this number represents the annual amount your mortgage lender charges you to borrow money. If you have a fixed-rate mortgage, that rate will stay the same for the duration of the loan. With an adjustable-rate mortgage, you'll typically have a lower interest rate for a fixed period, after which it can fluctuate from year to year. Your mortgage interest rate is determined by your lender based on things like your credit score and income, the current market rates, the size of your loan and your loan term. Your loan's interest rate is part of its annual percentage rate (APR); they are not interchangeable terms.
Lender: Mortgage lenders provide home loans. Many banks and smaller financial institutions like credit unions have home loan programs. You can also look to mortgage lenders that specialize in home loans. It's wise to shop around and compare interest rates and loan terms across multiple lenders.
Preapproval: A mortgage preapproval is often the first step in securing a home loan. During this process, the lender assesses your financial health by reviewing your credit report, credit score, assets, income, debts, tax returns, employment history and personal information. Once you're preapproved, you'll receive a letter stating how much you're authorized to borrow, along with your expected loan type, interest rate, fees and so on. Preapproval isn't a guarantee, however. You'll still need to complete a formal mortgage application process before the loan is issued.
Prequalification: Prequalification is less rigorous than preapproval, but it can help you understand your options. You'll typically have to answer a few simple questions regarding your assets, debts and income. After that, you'll be provided with a general idea of your borrowing power, but not your expected interest rate, terms or fees. Prequalification normally doesn't require a credit check.
Origination fee: The origination fee is an upfront charge a mortgage lender may throw in to pay for certain costs related to your home loan. It could cover everything from preparing and underwriting the loan to processing your application.
Closing costs: This umbrella term refers to other fees you may encounter when finalizing your mortgage. Closing costs typically include your origination fee, along with fees associated with your home inspection, appraisal, application, title insurance, credit check and more. The final amount is usually equal to 2% to 5% of the home sale price.
Uniform Residential Loan Application: The uniform residential loan application (URLA) is the standard mortgage application used by most lenders. Be prepared to provide a wealth of information regarding your employment history, income, assets, debts and more.
Fannie Mae and Freddie Mac: These federally backed mortgage companies are major buyers and sellers of mortgage loans. Fannie Mae and Freddie Mac buy mortgages from banks, then group them together before selling them to investors. This enables banks to lend more money to homebuyers. Loans that adhere to Fannie Mae and Freddie Mac lending standards are called conforming loans.
Escrow: There are two types of escrow accounts: those held by a third party during the homebuying process and those managed by the mortgage lender. The first type is used to hold your good-faith deposit during the mortgage transaction. The second type of escrow account is managed by the lender and is used as a holding place for homeowners insurance premiums and property tax payments. Instead of paying these bills yourself, your mortgage servicer will add these costs to your monthly mortgage payment, then pay them on your behalf using your escrow account. They're usually required if your down payment is less than 20%.
Mortgage insurance: If you don't have 20% to put down, you'll likely be required to pay for mortgage insurance in addition to your loan payment. Mortgage insurance is a way for lenders to reduce their risk because the insurer will assume your payments if you default on your mortgage. Private mortgage insurance (PMI) applies to conventional mortgages until your home equity equals or exceeds 20%. Federally backed mortgages, such as FHA loans, have their own mortgage insurance protocols.
Contingencies: Buyers can make their offer contingent upon certain requirements. For example, you may state that you will only buy the home after selling your existing property. You may also want the option to cancel the deal if your financing falls through or a home inspection reveals significant issues.
Income: When completing your mortgage application, your lender will ask you to determine your gross monthly income. Sources of income can include salary from a job, money from side gigs or self-employment income, alimony, child support income, rental income, capital gains and investment income, Social Security and more. The lender wants to make sure you can afford your new mortgage payment and that you've saved enough to cover your down payment.
Assets: The more high-value assets you have, the less risky you'll appear to lenders because you have more financial resources to draw from. When applying for a home loan, you'll be asked to list out the value of all your bank accounts and investment accounts (including retirement accounts), along with real estate properties and any other assets you have in your name.
Debt-to-income ratio: Lenders want to see how your debt obligations compare with your gross (pretax) monthly income. This is called your debt-to-income ratio (DTI). A lower DTI is preferred by lenders because it shows that you have room in your budget for a new mortgage payment. It's calculated by adding up your monthly debt payments, then dividing the total by your gross monthly income. For a conventional mortgage, borrowers typically need a DTI below 43%.
Loan-to-value ratio: This number represents your home loan amount as it relates to the home's current market value. Loan-to-value ratio (LTV) is determined by dividing the amount owed on the loan by the appraised home value, then multiplying that number by 100. To get a conventional mortgage, you'll want to shoot for an LTV of 80% or less.
How to Prepare for the Homebuying Process
Now that you're up to speed on important mortgage terms, it's time to prepare for the homebuying process. The first step is checking your credit score and credit report. Doing so allows you to get an idea of where your credit stands; if need be, take the time to improve your credit situation before you submit your loan application.
It's also wise to keep credit card balances low and avoid applications for new credit in the months leading up to your mortgage application as they can reduce your credit score. Similarly, paying all your bills on time and reducing your debt can help improve your score ahead of buying a home. Saving for a larger down payment can also make you a more attractive borrower and reduce your monthly mortgage payment.
The Bottom Line
Maintaining strong credit is one of the best ways to secure a good interest rate on a mortgage. Free credit monitoring with Experian can help protect your credit by alerting you to potential fraud with real-time alerts. It also provides credit score tracking so you can visualize your progress before buying a home.