Mortgage Vocabulary: Terms You Need to Know

Buying a home is likely to the be the biggest purchase you'll ever make, and it comes with a learning curve to boot. There's so much language to learn—what is an “ARM,” and how does it differ from a fixed-rate mortgage? You know you have a good credit score, but what does “debt-to-income ratio” even mean?

So, before you sign a mortgage or even begin your house search, it’s important to familiarize yourself with mortgage vocabulary. Let's take a closer look at some of the terms you're likely to encounter on the road to homeownership.

Why Understanding Mortgage Terms Is Important

When you close on a house and sign your mortgage documents, you’re entering into contractual agreements that have the force of law—and certain words have specific meaning in the law. Some mortgage vocabulary terms have different meanings in other contexts, so you want to be aware of what they mean before you sign all that closing paperwork.

Basic Mortgage Terms to Know

You’ll want to get familiar with the following mortgage terms as you search for your new home. Before you sign any contract, make sure you consult an attorney if you’re unclear about any of the terms.

Amortization

A breakdown of the monthly payment schedule for a loan, including the amount you’ll pay toward interest and principal each month. For mortgages, you'll pay more toward interest early in your mortgage term, and more toward the principal balance later on.

Appraisal

An estimate of a property’s current market value based on professional inspection and comparison to similar real estate in the area. If you’re selling your home, making certain improvements can help you boost your property’s value.

Annual percentage rate (APR)

APR is the total yearly cost of borrowing money from a lender, including interest, fees, insurance, and points, expressed as a percentage of your mortgage.

Adjustable-rate mortgage (ARM)

An ARM is a mortgage with an initial fixed-rate period, after which the rate goes up or down yearly depending on the market. You usually get to keep that fixed introductory rate for six months to 10 years, depending on your lender.

Balloon payment

A balloon loan amortizes only a portion of the total loan over the term period, and requires a large payment of the remaining balance due at the end of the mortgage term. Tread carefully with loans like this, as they can throw your finances into turmoil if you're not planning around that expected larger payment.

Closing

The completion of a real estate transaction when legal documents are signed, fees are paid, funds are disbursed, and the seller hands over the keys to the home. Closing is when you officially become a homeowner.

Credit score

Your credit score is a number representing your creditworthiness to lenders, determined by your credit history, outstanding debts, payment history, and other factors. Mortgage lenders will take your credit score into consideration when deciding whether to approve your application and what interest rate you qualify for.

Debt-to-income ratio (DTI)

Your total monthly debt divided by your total monthly income. It indicates what percentage of your income is used to pay off debt. The lower your debt-to-income-ratio, the better your chances of qualifying for a mortgage.

Down payment

The amount you pay upfront to the lender to secure the loan. Depending on the lender and mortgage type, down payments range from 3.5% to 20% of the selling price. The larger the down payment, the lower your monthly payments are likely to be.

Earnest money

A payment you make in good faith to the seller to show that you are invested in buying the home. This money is ultimately applied toward the down payment.

Equity

The difference between the value of your home and how much you owe on your mortgage. If your home is worth $355,000 and you owe $200,000, you have $55,000 equity in your home. Home equity increases as you make payments on your mortgage. And you can borrow against it with a home equity loan or line of credit.

Escrow

A third-party bank account that you deposit money into before closing on the home. The seller can view the deposit in this account, but cannot take money out of the account until the home-buying process is complete.

Fixed rate mortgage

A mortgage loan with an interest rate and an amortized payment rate that does not change over the term of the loan. Many mortgages come with a fixed rate, and the term often ranges from 15 to 30 years.

Foreclosure

When a borrower fails to make their monthly mortgage payments and loses all rights to their home as a result. The lender seizes and sells the foreclosed home to recover their losses.

Interest rate

The percentage of a loan that a lender charges each period, either monthly or annually, for the borrower to borrow money. Your interest rate is part of your loan's APR.

Jumbo loan

A mortgage loan in an amount that exceeds the limits set by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These loans generally have higher interest rates to account for the greater risk involved.

Loan term

The amount of time during which a borrower makes monthly payments toward a loan. Once a loan term ends, the loan should either be repaid or refinanced for another term.

Loan-to-value ratio (LTV)

An assessment of lending risk that a lender considers before approving a loan, calculated by dividing the total loan amount by the appraised value of the home. For example, if you make a 15% down payment of $37,500 on a home worth $250,000, the loan total would be $212,500, and your LTV is 85%. If your LTV is 80% or higher, you may not need mortgage insurance.

Monthly payment

The installments paid to a mortgage loan every month. Your monthly payment goes toward both the principal balance and interest.

Mortgage

A loan that allows you to borrow money to buy property and repay the debt, plus interest, in monthly installments. Mortgages generally have long terms, often 15 to 30 years.

Origination fee

A fee that covers the costs of setting up a mortgage loan. Your lender is required to tell you how much they will charge you for an origination fee in your Loan Estimate.

Private mortgage insurance (PMI)

Insurance that protects the lender in case the borrower fails to repay the loan. A down payment of 20% or more typically prevents you from needing PMI for a conventional mortgage.

Points

Fees paid to the lender at closing that lower your interest rate, but cost you more upfront. Generally, one point costs one percent of your total loan and lowers your rate by 0.25%.

Principal

The balance owed on your loan minus interest. It is reduced when you make payments.

Property tax

An annual payment made to the government of the city in which your home is located. It is determined by the area and the type of property.

Refinance

A renegotiation of the terms of a loan in order to accommodate new circumstances. For example, you might use a refinance to extend the term period or change the interest rate on your mortgage to match current market rates.

Make Informed Decisions on Your Way to Financial Freedom

Whether you’re buying a new home or refinancing an existing one, it’s absolutely crucial that you have a solid handle on mortgage vocabulary. Similarly, learning how to deal with debt, money, and planning for your future doesn’t need to be difficult as long as you educate yourself. Freedom Debt Relief maintains a library of content to help you achieve your financial goals. You can check out our blog here.