Key Mortgage Terminology to know: A Guide to Commonly used phrases

If you're financing a home purchase, it's important to understand mortgage terminology. But becoming fluent can feel like learning a new language. Here's our guide to key mortgage terms and conditions, from A(PR) loans to V(A) loans, to demystify the process and help you find finance.

Adjustable Rate Mortgage (ARM)	Escrow	Origination Fee
Amortization	FHA loan	PITI
APR	Fixed-rate mortgage	Points
Cash-out-refinance	Forbearance	Pre-approval
Closing Costs	Foreclosure	Principal
Conforming Loan	Interest rat	Private Mortgage Insurance
Construction loan	Jumbo loan	Refinance
Conventional Loan	Loan estimate	Reverse Mortgage
Debt-to-income (DTI) ratio	Loan-to-value (LTV) ratio	Underwriting
Down payment	Mortgage Insurance	USDA Loan
Earnest Money	Non-QM loan	VA loan
Equity

 

Adjustable Rate Mortgage (ARM)

An adjustable-rate mortgage is one in which the loan's interest rate changes at a predetermined time every six months. There is usually an initial "growth" period when interest rates are particularly low, even lower than those of fixed-rate mortgages. After that, interest may rise or fall depending on market conditions.

Amortization

Amortization describes paying off a debt, such as a mortgage, in installments over time. Part of each payment goes towards the principal (the amount borrowed), while the other part goes towards interest. A typical mortgage loan can be amortized over a 15- or 30-year term, and the amount allocated to interest and principal will decrease and increase over time. When a loan is fully forgiven or matured, it is paid off in full at the end of the amortization schedule.

APR

The APR, or annual percentage rate, reflects the cost of a mortgage loan. APR, on a broader scale than the interest rate, includes interest rates, discount points, and other loan fees. The APR is higher than the interest rate and better indicates the loan's actual cost.

Cash Out Refinancing

A cash-out refinance is a type of mortgage that allows you to access some of the equity in your home in one lump sum. This process involves taking out a large second mortgage to replace the first mortgage. The new loan combines the outstanding balance of the first mortgage and the cash you take out and comes with a new interest rate and term.

Closing costs

Closing costs are the fees associated with obtaining a mortgage. These include several fees paid when signing or closing a loan, such as origination, appraisal, credit report, and title search fees. Both buyers and sellers incur closing costs, which the buyer often bears, but sometimes sellers cover some of these costs.

Conforming loan

A conforming loan is a mortgage that meets the lending guidelines and limits established by the Federal Housing Finance Agency (FHFA). Guidelines include the borrower's creditworthiness, debt-to-income ratio, and downpayment criteria. Loan limits, which change yearly and vary by county, set the maximum amount of debt that government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac are willing to buy or guarantee. By following these guidelines, lenders can sell these loans to Fannie Mae and Freddie Mac, reducing their risk and allowing them to offer better terms to borrowers.

$766,550

The 2024 maximum conforming loan limit in most parts of the US Can be as high as $1,149,825 for high-cost real estate areas.

Source: Federal Housing Finance Agency

Construction loan

Construction loans are short-term financing used to build a home, typically with a one-year term. With this type of loan, you withdraw the money at predetermined stages of the project. There are two main types of construction loans: construction only and permanent construction. The construction loan must only be paid off when the home is completed (or transferred to a conventional mortgage). A permanent construction loan becomes a mortgage when the house is finished.

Conventional loans

A conventional loan is any mortgage not backed by the government but funded entirely by the private sector. Unlike FHA, VA, and USDA loans, which are insured or guaranteed by federal agencies, a conventional loan is backed by the lender that issues it. Conventional loans typically require a 20 percent down payment. Some now charge less but then charge private mortgage insurance (PMI).

Debt-to-Income Ratio (DTI)

The debt-to-income ratio (DTI) measures borrowers' mortgage repayment ability. It is calculated by adding up all the borrower's monthly loan payments and dividing the total by the borrower's gross monthly income. For example, if the borrower's loan payments total $4,000 per month and his gross monthly income is $10,000, the DTI ratio would be 40%.

Accumulation

A down payment is the cash payment a buyer makes to purchase a home. A larger down payment can improve a borrower's chances of getting a lower interest rate. Different types of mortgages have separate minimum payments.

Money Guarantee

Earnest money is a deposit a home buyer makes when entering a Home Purchase Agreement (PSA), usually as a sign of good faith. The deposit is generally held in an escrow account with the title company. When the home sale closes, the equity goes toward a down payment or closing costs. If the sale falls through, the deposit is returned to the buyer or seller, depending on whether the reason for termination was allowed in the PSA.

Equity

Equity is the percentage of your home that you own outright. This represents the portion of your house paid off (and paid for directly through your down payment). For example, if a home is worth $300,000 and your mortgage balance is $100,000, your equity is $200,000. You can borrow against the equity in your home to get cash.

Escrow

An escrow account, also called an impound account, holds the portion of a borrower's monthly mortgage payment earmarked for homeowners insurance premiums and property taxes. Escrow accounts also contain escrow money that the buyer holds between accepting your offer and closing. An insurance and tax escrow account is usually established by the lender or mortgage servicer, which pays the insurance and taxes on behalf of the borrower. This system assures the lender that those invoices have been paid.

FHA loan

FHA loans are mortgages insured by the Federal Housing Administration (FHA). This means the FHA has your back. In case of default, it will compensate the borrower, reducing the risk to the lender (who finances the loan). As a result, FHA loans typically require more flexibility and lower down payments than conventional loans. They are especially popular with first-time home buyers.

Fixed-rate mortgages

A fixed-rate mortgage is a loan whose interest rate remains the same for the entire term (life of the loan), unlike an adjustable-rate mortgage, whose interest rate fluctuates based on market conditions. Borrowers can only renew the interest rate on fixed-rate mortgages.

Forbearance

Forbearance refers to a short break in mortgage payments, usually due to financial hardship. After the forbearance period ends, homeowners can pay off missed payments in one lump sum, enter a payment plan, or request a loan modification.

Foreclosure

A foreclosure occurs if a homeowner stops making mortgage payments. This default allows the lender to take possession of the home, which has served as collateral for the loan. Foreclosure allows the mortgage lender to sell the house and collect the money owed.

Interest Rate

The interest rate on a loan represents what a lender charges someone to borrow money from. It is expressed as a percentage applied to each mortgage payment. A lender's interest rate reflects general market movements and the borrower's risk level. Short-term loans usually have lower interest rates than long-term loans (since the borrower gets their money back sooner). People with better credit scores often qualify for lower interest rates than applicants with questionable credit histories.

Jumbo loan

A jumbo loan is for more extensive and expensive properties that exceed general standards set at the federal level, known as "conforming loans." Most mortgages fall within these favorable limits, meaning banks can only lend a specific amount based on the geographic area where the home is located. For most of the United States, the maximum value is $766,550. In more expensive areas, the conforming loan limit is $1,149,825 (in 2024). You will need a jumbo loan if you need more money than that.

Loan Estimates

A loan estimate is a standard three-page document containing details about the mortgage given to borrowers when they apply for a loan. It includes forecasts of interest rates, monthly payments, total closing costs, taxes, insurance, prepayment penalties, and other important information about the loan. Loan estimates are designed to make it easier for borrowers to compare terms when shopping for a mortgage. Receiving one means you have yet to be approved or rejected for a loan.

Loan-to-value ratio (LTV)

The loan-to-value ratio, or LTV ratio, compares the mortgage amount to the property's value. An LTV ratio of 80 percent or less (equivalent to a 20 percent down payment) has been the traditional standard for conventional loans. An LTV ratio above 80 percent means you'll need to purchase mortgage insurance, which is an additional expense. Some government mortgages, such as FHA or VA loans, allow higher LTV ratios and may or may not require mortgage insurance.

Mortgage Insurance

Mortgage insurance is usually required for mortgage loans, with a buyer paying less than 20 percent. The borrower pays the premium, usually as part of their monthly mortgage payment. This additional fee protects the lender if you default on your loan, helping you recover your funds. The two primary types are private mortgage insurance (PMI), which is applied to conventional loans, and mortgage insurance premiums (MIP) on FHA loans.

Non-QM Loans

A non-QM loan (short for non-qualified or non-qualified mortgage) does not meet the Consumer Financial Protection Bureau (CFPB) standards. They are designed to provide financing options to borrowers who do not meet traditional income, financial, or creditworthiness criteria but can still demonstrate the ability to make mortgage payments through alternative means. Because non-QM loans present a higher level of risk to borrowers, they often have different terms and conditions and higher interest rates than standard mortgages.

Origination fee

A lender charges an origination fee to originate, process, and guarantee your loan. In most cases, mortgage origination fees are between 0.5 and 1 percent of the total loan amount and are due at closing.

PITI

PITI is an acronym for the four parts of a mortgage payment: principal, interest, taxes, and insurance. The portion of your payment that covers principal, or the amount borrowed, and interest goes to the lender as payment. Another portion covers property taxes and homeowner's insurance premiums and can be held in an escrow account.

Points

Borrowers can buy discount points, also known as mortgage points, to lower the interest rate on their loans. Typically, a point costs 1 percent of the loan amount and reduces the rate by 0.25 percent (although this can vary by lender). The value of the points is included in the loan estimate and is paid by the borrower at closing. Typically, borrowers purchase points to reduce interest over the life of the loan, so buying them may only be worthwhile if the borrower owns the home long enough to cover the initial cost. Lives.

Pre-approval

A pre-approval is a status that a borrower receives from a mortgage lender, indicating that they are willing to provide a certain amount of money to purchase a home. This does not mean that the borrower is guaranteed the loan, but it does show that they are in a solid position to obtain financing (which they can demonstrate to sellers through a mortgage commitment letter). It is issued when the lender conducts a credit check and gathers financial information about the borrower.

Principal

Mortgage principal is the amount you initially borrowed from the bank or lender—your loan amount. Interest, in contrast, is what a lender charges you to borrow money. Monthly mortgage payments consist of both principal and interest payments.

Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is a type of coverage that a borrower must purchase when paying less than 20 percent for a conventional loan. PMI protects the lender, not the borrower, from loss if the borrower stops making loan payments. When refinancing, PMI is required if the borrower's home equity is less than 20 percent of the property's value.

Refinance

Mortgage borrowers can refinance with a new loan with a different rate, term, or both, using the new loan to pay off the existing loan. Borrowers are not required to refinance with the same lender that has their current mortgage. A common reason to refinance is to get a lower interest rate, usually because economic factors have lowered rates or the borrower's credit has improved. Another common reason to refinance is to shorten the loan term to pay off the mortgage faster and reduce the total interest paid.

Reverse mortgage

Reverse mortgages are available to homeowners of a certain age (usually at least 62 years old, although some loans are as young as 55) and who have sold their homes. Under this agreement, a lender makes monthly payments to the homeowner. The owner is borrowing from his cash capital. Repayments are tax-free and may also be interest-free (meaning the borrower does not have to make any payments during his lifetime). When the borrower dies, sells, or permanently leaves the home, the lender is returned, or the property is repossessed.

Underwriting

Mortgage underwriting is the process by which a bank or mortgage lender assesses the risk it will take to lend to a particular borrower. The underwriting process considers the borrower's credit report and score, income, debt, and the price of the property they want to purchase. Many lenders follow standard Fannie Mae and Freddie Mac underwriting guidelines when determining whether to approve a loan.

USDA loan

USDA loans (Rural Development Loans) are offered to people who want to buy homes in some rural regions. Issued by private lenders, they are guaranteed by the United States Department of Agriculture. They offer generous terms (no down payment required), but applicants must have a low or moderate income.

VA loan

The US Department of Veterans Affairs guarantees all VA loans. Both active-duty military members and veterans are eligible to apply. VA loans are attractive because they require no down payment, have no loan limit, and can be 100% financed (assuming the borrower is fully qualified).