Home loans come with a language all their own. Don’t know an FHA from an ARM or an appraisal from an assessment? We can help. Here's a quick explanation of the most commonly used home loan terms. We'll have you speaking fluent mortgage in no time.
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Adjustable Rate Mortgage (ARM)
The rate on an Adjustable Rate Mortgage is — surprise! — adjustable. After the first six months to a year of your mortgage, your monthly payments will adjust — up or down — based on an index chosen by your lender, such as treasury bill or cost of funds. Most ARMs have both an annual cap (usually 2% up or down) and a lifetime cap (usually 6% up or down).
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Annual Percentage Rate (APR)
Annual Percentage Rate (APR) includes not only the interest that has to be paid on a loan, but also certain specific costs associated with the loan, such as origination fees and discount points. Different lenders charge different interest rates and different points. The APR provides a useful gauge for comparing the total cost of different mortgage loans.
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Appraisal
An appraisal is the monetary evaluation of the property you’re interested in buying. The lender uses this dollar amount to determine how much the house is worth as collateral. Age, condition and size of the house are all factored in, as well as the recent sale price for similar houses in your area.
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Assessment
See all those fire hydrants and parks and street lights in your neighborhood? Your taxes help pay for them — along with schools, police and libraries. To calculate your share of the community tax bill, your house is “assessed” a property value by the county assessor. Standard tax rates average from $12 to $14 per $1,000 of your home’s value. So if your home is assessed at $150,000 and your county charges $12 per $1000 of value, you pay $1,800 a year in property taxes. This amount may be included in your monthly mortgage payment.
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Closing
The appraisal is back. The loan is approved. The papers are typed and ready for your signature. It’s time to “close” your loan. After all the papers are signed, the deed of trust and warranty deed are recorded and the house is officially yours — keys, mortgage and all!
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Closing Costs
Closing costs are the one-time charges and fees associated with completing — or closing — a home loan. Some of the closing costs are paid to third parties, such as appraisals, title and escrow fees, courier costs, flood search fees and credit report fees. The remainder of the closing costs are paid to the lender to cover the costs of processing and closing the loan.
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Credit Report
Remember that student loan payment you missed in ‘94? It’s here, along with every credit card, auto loan and previous mortgage you’ve had in the past ten years. Things like outstanding credit balances and payment records provide your lender with an overall credit score — a number which helps them determine your credit worthiness.
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Deed
After weeks of wondering and thousands of dollars in fees, down payment and closing costs, this little piece of official-looking paper transfers ownership of the house from the previous owner (or builder) to you. Congratulations!
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Down Payment
Unless your name is Bill Gates, odds are you can’t pay for your new house with cash. Not to worry. A down payment is the amount of cash you need to pay to secure the mortgage. A minimum of 3 to 5% of the total sale price is usually required. Start saving!
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Earnest Money
No, it’s not the $5 you got from a relative back east. Earnest money is the deposit you make when you initially sign the purchase agreement, letting the seller know you are “in earnest” to purchase the property. The amount varies, usually in the $500 to $1000 range, and is non-refundable if you decide not to buy the house.
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Escrow
Escrow is a neutral third party who holds the legal documents and funds on behalf of a seller and buyer or lender and borrower, until the parties have met all of the conditions required to close the loan.
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Escrow Account
Every time you make a monthly mortgage payment, you are pre-paying 1/12th of the anticipated annual amount needed to pay for taxes and insurance. These funds are put into a pool called an escrow account. From this pool, the lender will pay your taxes and insurance as they become due. This allows the borrower to spread tax and insurance payments throughout the year, rather than a large lump sum. Since the money is being paid before it's actually due, an escrow account gives the lender greater control in avoiding tax delinquencies or lapses in insurance coverage on the property. Escrow accounts are usually mandatory unless you're paying 20% or more as a down payment.
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FHA
These three letters are shorthand for Federal Housing Administration, the government agency that insures home loans.
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Good Faith Estimate
As a way of comparison shopping for a mortgage, a lender will prepare a “good faith estimate” of settlement costs. This is a detailed list of all of the closing costs, prepaid expenses and settlement charges related to the loan. By law, the lender is required to provide you with a good faith estimate within three days of completing a loan application.
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Locking Your Rate
Rates change every day — sometimes more than once in a single day. In order to guarantee a certain rate, at some point in the loan process you need to “lock” your rate. This ensures that if rates go up, you still get the rate you locked.
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Origination Fee
An origination fee is an amount of money collected by the lender for allowing you to borrow money to buy your house. This fee, sometimes known as "points," is usually expressed as a percentage of your total loan amount. For example, your origination fee might be 1% of your loan amount.
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Prepaids
Prepaid expenses, or "prepaids," cover the cost of property taxes, homeowners insurance, mortgage insurance and interest from the date of you close your loan through the date you make your first payment. These expenses are collected by the escrow agent at the time of closing.
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Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is a type of risk insurance provided by private carriers, designed to protect the lender if the borrower defaults. Many home-buyers don't have the required 20% down payment. Because of the increased risk, lenders are hesitant to lend money at market interest rates for more than 80% of the home's value. So PMI covers the lenders risk on loans with less than a 20% down payment. If you are required to have PMI, the premium will be included in your monthly mortgage payment.
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Points
A point is equal to 1% of the loan amount. Discount “points” may be charged to lower your interest rate. For example, if today’s loan rate is 7.5% but you’d like a better rate of 7%, the lender may charge you one or more points to obtain this lower rate.
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Title Insurance
This mandatory insurance policy protects your interest in the property against any other claims. Title insurance is a one-time payment that’s factored into your closing costs. The price of the insurance varies, with the cost based on the amount of your loan.
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Truth In Lending
This form shows you the Annual Percentage Rate of your mortgage, the total amount of payments over the life of the loan and discloses other information, such as prepayment penalties (if any) and late charges. This government-required form is a real eye opener!
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