One of the most anxiety-producing experiences for the average American is the purchase of a home. It is the costliest investment he or she will ever make, and there are a multitude of issues to consider. Navigating through an ocean of mortgage terms requires a basic understanding of the financial jargon. In view of the importance of the mortgage commitment, the numerous documents involved in a mortgage transaction, and the potentially adverse consequences of signing a contract without grasping its substance, it becomes imperative for consumers to familiarize themselves with the current mortgage loan terminology. What follows is an introduction to some of the most commonly-encountered mortgage terms:
Loans begin with an originator, the mortgage creditor in charge of funding them. Loan originators are financial institutions such as credit unions and banks. Before issuing a loan, banks delegate to brokers the task of scouting and pre-qualifying borrowers. Pre-approval involves obtaining the applicant's credit report from the three main credit agencies, namely TransUnion, Equifax, and Experian. Mortgage companies then conduct an examination of the applicant's FICO or credit score for the purpose of assessing his or her debt-management record. By improving their credit rating and cleaning up their credit report, consumers can capitalize on the best mortgage deal. Mortgage brokers perform multiple tasks including the following: 1) assisting borrowers in the selection of a suitable and competitively-priced mortgage product that meets their needs and 2) guiding customers through the application process. In the pre-qualification stage, mortgage companies require a specific debt-to-income ratio- usually 28/36, which means that borrowers should not be allocating more than 28% of their income to paying off the mortgage. Additionally, they should not be utilizing more than 36% of their income to pay off their monthly debt (i.e. credit cards).
Consumers shopping for a home loan should research the current mortgage rate charged by various creditors nationwide. Hundreds of mortgage websites offer visitors the opportunity to access, via a few clicks of the mouse, the best mortgage rates that are a perfect fit with their needs and financial circumstances. Changes in mortgage rates correspond to leading economic indicators, such as the stock exchange. To protect themselves from interest rate hikes during the loan processing period, consumers can request a rate lock. To time their rate lock so as to reap interest rate savings, prospective borrowers should pay attention to leading economic indicators and track trends in the mortgage market.
Home buyers can choose from a wide variety of home loans including the following:
1. Fixed-rate mortgage (or FRM)
Also known as a conventional mortgage, this type of home loan boasts a rate of interest that remains steady throughout the term of the loan. This type of mortgage protects borrowers against rate increases as well as simplifies planning and budgeting since the borrower's monthly payments always remain the same.
2. Adjustable rate mortgages (ARM)
Alternatively referred to as a variable rate mortgage, this home loan boasts a low rate of interest during the introductory period, after which it is adjusted at regular intervals in accordance with a pre-selected index. The interest rate fluctuates depending upon market conditions and national rates. Some ARMs incorporate both adjustable and fixed interest rates and are thus known as "hybrid loans". For instance, a 5/1 ARM has a fixed rate of interest for 5 years; thereafter, the rate adjusts every year. There are caps or limits on the amount that the monthly payments or interest rate on an ARM may change.
3. Government loan
The Veterans Administration (VA) and the Federal Housing Administration (FHA) process the vast majority of home loans.
4. Jumbo mortgage
Also known as a non-conforming mortgage, this loan exceeds the loan amount limits set by secondary market creditors- Freddie Mac and Fannie Mae. The interest rate on a jumbo mortgage is usually higher than that on a conforming mortgage.
5. 100% mortgage
This type of home loan enables consumers with little or no cash to buy a home without making a down payment. In a 100% mortgage, a borrower typically pledges stocks and bonds as security for the loan. The lender extends to the borrower a loan amount that equals the home's total value.
6. Reverse mortgage
This loan is designed to convert a borrower's equity in his or her home into cash. Reverse mortgages are of particular benefit to elderly homeowners (i.e. usually 62 years of age or older) since they allow them to utilize their home equity without moving out or selling their property. Borrowers are not required to make any repayments until they die or no longer utilize the house as a primary residence. Mortgage companies issue a stream of payments to the borrower for life.
7. Second mortgage
Borrowers may apply for a second mortgage in order to finance a vacation home and home improvements or to consolidate consumer debt with a lower rate of interest. Borrowers pledge the home as collateral, and if they default on the second mortgage, the first mortgage takes priority and is paid off first.
8. Interest-only mortgage
With this type of home loan, prospective borrowers repay solely the monthly interest throughout the term of the mortgage. On the date of the loan's maturity, they pay off the principal balance.
Another term with which homeowners should become acquainted is APR, which stands for annual percentage rate. This tool, which represents the total cost of a mortgage and is expressed as an annual rate, assists borrowers in comparing loan products. The different finance charges that are taken into account when calculating the APR includes origination fees, discount points, and prepaid interest. Also known as mortgage points, prepaid interest is charged by the lender at closing. One point corresponds to 1 percent of the loan's amount. Generally, the lower the rate of interest, the higher the amount of points.
To obtain a mortgage, consumers must make a down payment, which is a lump sum that they pay up front and which usually comprises 5 to 20% of the sales price on conforming loans. The principal represents the loan's total amount, and is determined by subtracting the down payment from the property's price. Mortgage payments are amortized or paid off in equal, incremental amounts over the course of the loan; these decrease the principal. Some mortgage lenders charge borrowers a prepayment penalty for paying off the mortgage prior to its maturity or due date. To protect against loss in the event of default, lenders require that homeowners purchase mortgage insurance (PMI) if their equity in the property is less than 20% or their loan-to-value ratio exceeds 80%.
By: Yara Zakharia, Esq.
