There is a lot to learn when it comes to home mortgages, especially if you are a first time homebuyer. Certain mortgage terms you may come across during the process of securing your home mortgage may be quite confusing and overwhelming, yet understanding them is extremely important for making informed decisions.
Here is a brief description of 10 mortgage terms that you are likely to encounter during the process of securing your home mortgage:
- Pre-qualification: It is an estimate of how much you can afford in a mortgage payment. It is based upon the information provided by you and is subject to the approval process, including further details such as a credit report, appraisal, and income verification.
- Pre-approval: Unlike a pre-qualification, a pre-approval is a firmer commitment by the mortgage provider and is a more formal process which includes a credit check and even employment verification. During a pre-approval the mortgage company does all the work of a final approval, except for the appraisal and title search.
- Fixed Rate Mortgage (FRM): As the term suggests, in an FRM, the interest rate remains the same (the term “fixed”) throughout the life of your loan (i.e., 5% for 30 years). An FRM offers mortgage rate and payment stability and is typically more preferable if you plan to live in the same house for 7 years or longer.
- Adjustable Rate Mortgage (ARM): Unlike an FRM, an ARM is a mortgage type in which the interest rate adjusts to a new rate (the term “adjustable”) after the expiration of the initial mortgage term (for example, 5/1 ARM means your interest rate will remain the same for the initial term of the first 5 years and will then adjust every year to a new rate starting from year 6). Compared to an FRM, an ARM offers lower interest rate during the initial term but higher volatility in your mortgage rate and payment after its expiration, making it more preferable if you plan to live in the same house for less than the initial mortgage term.
- Government-insured mortgage: The examples of government-insured mortgages include FHA, VA and USDA loans. They are insured either partially or completely by the government and offer lower down payment requirement (typically 3% to 5%) and less stringent mortgage-qualifying standards but carry a higher interest rate as compared to the conventional mortgages.
- Conventional mortgage: Unlike government-insured mortgages, conventional mortgages are not insured by the government. They come in various types and features such as fixed or adjustable interest rates.
- Private Mortgage Insurance (PMI): Since the conventional mortgages are not insured by the government, you may be required to purchase a PMI, which is a type of mortgage insurance used with conventional mortgages to protect the lender in case you default.
- Discount points: They are actually prepaid interest on the mortgage loan. A point is equal to 1% of the loan amount. The more points you pay, the lower the interest rate on the loan and vice versa.
- Appraisal: It is a process of estimating the value of your property by a qualified professional appraiser. A home appraisal is required by the lender.
- Title insurance: It is an insurance policy that protects your and your lender’s financial interest in property against losses due to title defects, liens or other title-related matters.
Knowing common mortgage terms helps you make informed decisions while going through the process of securing one the biggest loans of your lifetime.
Managing Partner, Options Mortgage Services