To the average person, mortgage terms can seem complicated to the verge of being indecipherable. You may understand the basics, like the interest rate you’re going to pay and how long the mortgage is going to last. But the finer details can easily get lost in translation.
How do you make mortgage terms simpler to understand?
Start With the Basics: Key Terms You’ll See Again and Again
Let’s cut through the fluff and tackle the most important mortgage terms you’ll encounter.
- Principal. This is the base amount you borrow from the lender. So if you take out a $300,000 mortgage, that’s your principal, before any interest is added.
- Interest. This is what the lender charges you for borrowing the money. It’s expressed as a percentage rate and added to your monthly payment.
- Term. This is how long your loan will last, and it’s typically 15 or 30 years. A longer term usually means lower monthly payments, but more interest paid over time.
- Fixed-rate vs. adjustable-rate. Fixed-rate mortgages have the same interest rate for the life of the loan. Adjustable-rate mortgages (ARMs) can change after an initial period, meaning your payment could go up (or down) over time. Fixed rates are generally preferable for most borrowers.
- Escrow. Your lender may set up an escrow account to collect property taxes and homeowner’s insurance as part of your monthly payment. They hold that money and pay those bills on your behalf.
- PMI (Private Mortgage Insurance). If your down payment is less than 20 percent, you’ll likely pay PMI, which is an added monthly fee to protect the lender in case you default. It usually drops off once you hit 20 percent equity.
- Amortization. This is how your payments are spread out over the life of the loan.
Break Down the Monthly Payment
Your mortgage payment isn’t just about paying off your loan. It’s usually made up of several pieces, sometimes remembered using the acronym PITI: Principal, Interest, Taxes, and Insurance. Knowing what’s included in your payment helps you understand exactly where your money is going and lets you spot potential surprises in your budget.
Get to Know Your Loan Estimate
When you apply for a mortgage, your lender will give you a loan estimate. This is a standardized document that outlines all the key details of your potential loan. It includes your loan amount and interest rate, your estimated monthly payment, closing costs for which you may be responsible, estimated taxes and insurance, and your total cost over time.
This is one of the most important documents you’ll receive during the process. It’s designed to be easy to understand and easy to compare across lenders. Make sure you understand this document thoroughly before you make any major decisions.
Know What Affects Your Rate and Approval
If you’re still shopping for a mortgage or getting pre-approved, it helps to know the major factors that lenders use to determine your interest rate and terms.
- Credit score. Higher scores usually get better rates. A score of 740 or higher typically unlocks the best offers, while anything below 620 can make qualifying more difficult or expensive.
- Debt-to-Income Ratio (DTI). This measures how much of your monthly income goes toward debt payments. Most lenders look for a DTI of 35 percent or lower.
- Down payment. The more you put down, the better your terms tend to be. A down payment of 20 percent or more usually eliminates PMI and can get you a lower rate.
- Loan type. There are several types of mortgage loans, including conventional, FHA, VA, and USDA. Each has its own qualification rules, down payment options, and insurance requirements.
Ask These Questions Before You Sign
Even if your loan looks good on paper, you’ll want to ask a few key questions before moving forward:
- Can I consistently afford this monthly payment?
- Is there a prepayment penalty if I want to pay the loan off early?
- Are the property taxes and insurance estimates accurate for this area?
- Is this rate locked or could it change before closing?
- What’s the total cost of the loan over the full term?
A good lender will be more than happy to walk through all of this with you and answer any questions you may have. If they aren’t, consider it a red flag.
Conclusion
Mortgages come with their fair share of unfamiliar terms, but understanding them doesn’t have to be overwhelming. With a little effort and a few plain-English explanations, you can feel confident in your decisions, and avoid costly surprises down the road.
Whether you’re a first-time buyer or just looking to refresh your knowledge, taking the time to understand your mortgage options puts you in control of this significant investment. Don’t be afraid to ask questions, compare lenders, and insist on getting clarity when you need it.
