Decoding Mortgage Terms
Buying a home is a huge deal (hello, Captain Obvious). But how can you make an informed decision if you don’t understand the lingo? Here’s a breakdown of common mortgage-related terms to help you make sense of the madness.
Types of home loans
- Conventional loans: As the name suggests, conventional loans are the most common type of mortgage. Applicants typically need credit scores of 620 or higher to qualify and may need a down payment of at least 20% to avoid paying private mortgage insurance (PMI). Conventional loans are not part of any government-backed program.
- FHA loans: Backed by the Federal Housing Administration (FHA), borrowers can qualify for these loans with as little as 3.5% for a down payment and credit scores as low as 500, but you’ll have to pay two different types of mortgage insurance (you won’t have to pay PMI, though).
- VA loans: Military members may qualify for a VA-backed mortgage if they’ve reached a set time commitment related to service. Down payments and mortgage insurance are not required, and there’s no set minimum credit score to qualify. However, borrowers will pay a funding fee of 0.5% to 3.6%.
- USDA loans: The U.S. Department of Agriculture (USDA) offers these loans to help low- to moderate-income families purchase homes in rural areas. No down payment is required and loan terms can extend past 30 years. Credit scores of roughly 640 are required, though other qualifying factors may be considered in lieu of credit.
Repayment terms
- Fixed-rate mortgage: This type of mortgage has a set interest rate that’s determined when you take out your loan, and that rate doesn’t change for the duration of the loan.
- Adjustable-rate mortgage (ARM): The interest rate on an ARM can change over time. At set intervals — anywhere from one month to several years — the rate will begin to adjust on a recurring basis. ARMs often start at lower rates than fixed loans, but over time the interest rate may increase significantly.
- 15-year vs. 30-year mortgages: A 30-year repayment term is common for most buyers. However, a 15-year repayment term can be a good option for those who are able to afford a much higher monthly payment. The main benefit is that borrowers will save money on interest fees that would accrue over the longer repayment period.
Other terms you should know
- Debt-to-income (DTI) ratio: Your DTI ratio is a calculation of your monthly debt payments (including mortgage) versus your gross monthly income (the total you make each month before taxes). Lenders may not approve you for a loan if it pushes your debt
- Loan estimate: This is a document that contains all the important details on your mortgage, including your repayment term, interest rate and closing costs. Your lender is required to provide you with the document within three business days after you complete your loan application. It's a good idea to review this with your loan officer to make sure you understand it clearly.
- APR: The total rate you will owe your lender, including your interest rate, plus all of the lender’s fees including closing costs and origination fees. This number is a more accurate representation of what you will owe than your interest rate, which takes less into account.
- Mortgage points: Some lenders will let you reduce your interest rate by buying “points.” For every mortgage point you buy, you’ll reduce your interest rate by 1%. The longer you stay in your home, the more points pay off. So, if you don’t expect to be in your home for long, buying points probably isn’t worth it.
