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Common Mortgage Terms and What They Mean, In Plain English
ARM or Adjustable Rate Mortgage: This type of mortgage loan typically offers a lower rate to you, initially. It is fixed or unchanged for a set period of time�1, 2, 3, 5, 7 or 10 years. After that period, it will adjust based on current market conditions. Most people will typically refinance before the adjustment or shortly thereafter. You may hear an ARM described in terms of 1/1, 3/1, 5/1, 2/28, 3/27, etc. 2/28 or 3/27 means it�s fixed for the initial period of 2 or 3 years, but the loan payments are calculated over a 30-year term. This type of mortgage is suitable for you if: 1) you don�t plan on staying in the home for a long period of time, 2) you need a lower interest rate initially to keep your mortgage payment lower (helps you buy more home for lower payments).
DTI or Debt-to-Income Ratio: This term refers to the amount of your monthly debt payments (including revolving debt like credit cards, installment payments like auto, child support/alimony, rent or mortgage payments). Debts that have less than 10 months until repayment are not included. That total amount of debt is divided by your total gross income (before taxes are taken out). Ideally, that number will be less than 50%.
Escrow: An escrow account in the mortgage business typically refers to a �savings� type account set-up for the borrower that includes the payments for their homeowner�s insurance and property taxes. The monthly escrow amount (1/12th of the annual amount) is added to your monthly mortgage payment, based on the actual amount of your homeowner�s premium and property taxes. For example, if your homeowner�s insurance is $360 per year and your property taxes are $600 per year, then $80 per month would be added to your monthly payment and that amount would go into an escrow account on your behalf. Your mortgage company would take care of dispersing the funds to your homeowner�s insurance company and the tax collector in your county. Most mortgage lenders offer this option, but don�t assume it is available unless you ask. Also, some lenders require you to escrow or they will charge you an additional �escrow waiver� fee at closing.
Fixed Rate Mortgage: This type of mortgage loan means that the interest rate is fixed for the entire term of the loan, typically 10-30 years. This type of loan is beneficial if you plan on remaining in the home for a long time and don�t want to worry about refinancing in the future. You do, however, always have the option if refinancing would result in a lower interest or payment.
Hazard or Homeowner�s Insurance: This refers to the insurance that you�re required to carry on your property. The amount of coverage needs to be at least equal to the amount of the mortgage. Most lenders require that one full year�s premium be prepaid before or at the time of loan closing. You are usually able to select the insurance company and agent of your choice, which may make you eligible for discounts if you already have other types of insurance (i.e. auto) with someone.
LTV or Loan-To-Value: This term refers to the amount of loan that you can qualify for in comparison to the value of the home. For example, if you qualify for a 90% LTV loan on a $100,000 home, that means you can get a loan for $90,000 and you would have to provide a 10% down payment or $10,000.
PITI: This refers to your monthly payment, which includes:
Principal
Interest
Taxes
Insurance
This term is only applicable to your mortgage if you escrow. TIP: When being quoted a monthly payment on a mortgage, find out if it is principal and interest only or if includes escrow amounts. Most mortgage consultants should be able to give you an estimate of a PITI payment if you have a specific property or price range in mind.
PMI or MI�Private Mortgage Insurance, Mortgage Insurance: This refers to an �insurance� policy that is required by some lenders when you put less than 20% down payment on a property. The amount is calculated based on the loan amount and the level of risk you provide as a borrower, similar to the way auto insurance is calculated. Many non-traditional lenders now offer 100% financing with no PMI. In exchange for that, they may charge a higher interest rate. This is not always a bad thing, however. Let�s look at two scenarios�one with PMI and one with no PMI.
With PMI Without PMI
$100,000 Loan $100,000 Loan
6.5% Interest 8.0% Interest
$632 Payment $733 Payment
$130 PMI $0 PMI
$762 Total Payment $733 Total Payment
The scenario with no PMI offers a savings of $29/month or $348/year. In addition to the monthly savings, there are greater tax benefits because the interest paid on a mortgage is tax-deductible, while PMI is not. Make sure you look at the total picture before agreeing to a mortgage program, just based on the interest rate offered.
Credit Scores: There is a lot of confusion over credit ratings and credit scores. Although I�m sure I can�t clear all of that up, I can offer some explanation on the way mortgage lenders use your credit scores. Typically when you apply for a mortgage loan, your credit report is �pulled� or accessed by that lender. A mortgage consultant will then try to find a loan program meeting your needs, based on your credit report. Your credit history typically generates three credit scores, one from each of the major credit bureaus. Most mortgage lenders will use your middle score as the score to qualify you for mortgage programs. If there is more than one borrower on the loan application, the middle score of the primary wage earner is used. Due to the fact that many times borrowers scores may range widely (for example, you may have scores of 590, 637, 676), some lenders have programs which will take the average of your top two scores. That�s beneficial for you, because your average is always higher than your middle score and you will typically qualify for a better program offering a higher LTV and/or lower interest rate.
All information contained herein is described in general terms. All definitions and examples may not apply to all mortgage scenarios. Consult your mortgage professional on the specifics of your situation. Exceptions may apply on a case-by-case basis.
