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7 Terms Every First Time Homebuyer Should Know

May 13, 2016 9:21:52 AM

Are you getting ready to buy your first home?

With all of the new terminology you're hearing, it can be overwhelming and difficult to know where to start.

So to ease your worries, we put together a simple list of terms that will help you navigate the homebuying process like a pro.

1. Adjustable Rate Mortgage (ARM)

Let’s start with an adjustable rate mortgage (ARM), also known as a variable-rate mortgage. When you decide to go with an ARM, your interest rate is likely to change based on how the market is doing. An index (a rate based on market conditions) and a margin (a rate set by the lender before you apply for a loan) are added up to determine your ARM interest rate.

Although an ARM may start with lower monthly payments than fixed-rate mortgages, they come with the risk that your payment will rise because the index changes. This type of mortgage structure is made to benefit a person who wants to make low payments for an extended term, as you may be fined for paying off an ARM early to reflect the future change in interest. In contrast, a fixed-rate mortgage may be a better choice for those who can make larger payments in a shorter term or those who may pay off their mortgage early.

2. Interest Rate and Annual Percentage Rate (APR)

Have you ever noticed two separate rates? Your interest rate is the amount you pay each year to borrow the money, while the annual percentage rate (APR) includes the interest rate plus additional charges that you pay for the loan. These charges may include other costs like points, private mortgage insurance, origination fees, and mortgage broker fees.

When you’re making the choice between an ARM and a fixed-rate mortgage, remember that the annual percentage rate on an ARM may be higher than the current rate as the index changes.

3. Loan-to-Value (LTV)

The loan-to-value (LTV) is the percentage of your new home’s value that your mortgage will cover. For example, a home valued at $200,000 with a $160,000 mortgage has an LTV of 80 percent.

This is one of the key factors lenders consider after appraising the home. Because the house is acting as collateral, lenders want to make sure they’ll be able to get the loan amount back if you default on your mortgage. Therefore, the higher the LTV amount, the riskier it is for the lender to loan out the money. And the lower the LTV, the lower your interest rate and APR will be.

4. Underwriting

Lenders want to make sure loaning out your mortgage is worth their risk. To determine this, they use a process called underwriting. The underwriter at the lender’s organization will obtain a thorough financial background from the potential borrower and analyze their detailed credit report.

In addition, the underwriter analyzes the appraisal of the home alongside the loan to ensure the home is worth enough to serve as collateral. To do this, they follow mortgage underwriting guidelines issued by the Federal Housing Administration (FHA), Fannie Mae, or Freddie Mac.

5. Private Mortgage Insurance (PMI)

If your down payment is less than 20 percent of your home’s price, lenders will ask you to purchase private mortgage insurance (PMI). This guarantees that the lender will get their money if you stop making payments on your mortgage. Typically, the borrower has to pay the insurance premiums until the LTV reaches 80 percent. However, certain loans require mortgage insurance regardless of the LTV.

6. Closing Costs

When you close on your mortgage, expect to pay closing costs in addition to the down payment. These costs may include lawyer fees, taxes, insurance premiums, survey charges, and miscellaneous fees. Closing costs generally add up to between two and five percent of the total cost of the home. You may be able to get the seller to pay part of the closing costs when negotiating the selling price of the home.

7. Points

Points, also known as discount points, are charges paid to the lender at closing in exchange for a lower interest rate. Think of points as an opportunity to pre-pay your interest. Any points you are able to pay can substantially reduce the total amount of interest you pay during the term of the loan. One point is typically equal to one percent of the loan amount.

For example, on a $250,000 mortgage, a point would be equal to $2,500. In exchange, the lender would reduce the interest rate by a certain amount, such as 0.25 percent. It’s important to decide if paying points is worth it to you. Typically, the longer you plan to have your house for, the bigger your savings will be if you buy points. If you plan to stay for a short period of time, you may not want to buy any points at all.

Speaking and understanding the lingo will help you through buying your first home with less stress.

Before long, you'll be the proud owner of a home you can afford and love for years to come.


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