If you’re new to the homebuying process, it’s a good idea to become acquainted with some common mortgage terms before applying for a loan. Here are six important terms related to home financing and their definitions.
Amortization
Amortization is the repayment of a loan through regular periodic installments. For example, if your mortgage loan has a 10 year amortization, this means you will be making monthly payments for 10 years, or a total of 120 payments. The total time period for a loan is also referred to as the term.
Annual Percentage Rate
Many mortgage lenders will present both the current interest rate for a loan and an annual percentage rate (APR). The APR is the rate of annual interest charged on a loan, including points and transaction fees. This rate is uniformly calculated by all lenders and can be used for comparison purposes because it encompasses more than the stated interest rate. The APR is a required disclosure according to the Truth in Lending Act.
Closing Costs
Closing costs are all expenses required to complete the home purchase outside of the actual purchase price. Closing costs may include things like fees for origination and home appraisal, title insurance, taxes and any points negotiated in the deal.
Home Equity
Home equity is your ownership stake in a home, calculated as the current market value less the mortgage principal outstanding. Each month your home equity should increase by the amount of the principal payment you make on your mortgage. Home equity does not include the interest portion of your mortgage loan payment.
Loan-to-Value
The loan-to-value ratio is the current principal balance of your mortgage compared to the fair market value of your home. Therefore, if your mortgage principal outstanding is $100,000 and your house is worth $150,000, your loan-to-value ratio would be 67 percent. If your LTV is greater than 80 percent you will most likely be required to purchase private mortgage insurance (PMI), which is an additional monthly cost on top of your mortgage payment.
Point
A point equals one percent of your mortgage principal. For example, if you are requesting a $100,000 mortgage, one point would equal $1,000. Some lenders allow you to pay points upfront in exchange for a lower interest rate. In this case, you should consider how long you intend to stay in your home before paying points upfront.
If you are new to the home loan process, a mortgage lender will be happy to provide further explanation for any unfamiliar terms you come across during the application process. Attending a first time homebuyers seminar may also be beneficial. For additional mortgage terms and definitions, check the BrightPath mortgage glossary.
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