These are some of the most common mortgage terms, explained.
Common Mortgage Terms for First-Time Homebuyers
Some of the most common terms you’ll hear as you apply for a mortgage loan include:
- Closing costs
- Debt-to-income ratio
- Down payment
- Fixed-rate and adjustable-rate mortgages
The term closing costs refers to the money you’ll have to bring to closing. Closing costs are fees your lender charges for the loan and other charges, such as:
- Appraisal fees
- Attorney’s fees
- Credit check charges
- Deed-recording fees
- Discount points
- Loan origination fees
- Title insurance
- Title searches
Closing costs are usually between 2 and 5 percent of your total loan’s price. Your lender will let you know approximately how much you’ll pay in a good faith estimate that it’ll send you before closing day.
Debt-to-income ratio, or DTI, is the percentage of your gross monthly income that goes toward paying your debts. It can include:
- Monthly rent or mortgage payment
- Alimony or child support payments
- Student loan payments
- Car payments
- Other monthly loan payments
- Credit card payments
- Other debts
Most lenders want your debt-to-income ratio to be below 36 percent. That is, you spend less than 36 percent of your gross monthly income on expenses like these.
A down payment is the amount of money you put toward buying a home; your lender puts up the rest. It’s a good idea to save as much as you can for a down payment (ideally, 20 percent or more) because your monthly mortgage payments will be lower. If you put down less than 20 percent, you’ll have to pay for private mortgage insurance, which covers your lender if you default on your payments. (The one exception to this rule is a VA loan, which doesn’t require PMI.)
Fixed-Rate and Adjustable-Rate Mortgages
A fixed-rate mortgage is a mortgage loan in which your interest rate stays the same for the entire life of the loan. If you sign the dotted line for an interest rate of 3.5 percent, that’s what you’ll pay for the next 15 or 30 years (or however long your mortgage will last).
An adjustable-rate mortgage, which is sometimes called an ARM, is one in which your interest rate can fluctuate. Usually, there’s an initial fixed-rate period that lasts 5, 7 or 10 years. After that, your interest rate can go up or down based on current mortgage interest rates.
Interest is money you pay your lender as a fee for borrowing money. You’ll pay back the money you borrowed plus interest. The interest rate your lender gives you will be lower if you have good credit and higher if you have a few blemishes on your credit report.
Points, which are part of your closing costs, are calculated as a percentage of the principal. One point equals 1 percent of your loan. Sometimes, they’re called discount points. Their purpose? To let you buy your way to a lower interest rate, which also lowers your monthly mortgage payments.
Principal is the amount of money you owe on your home. If you buy a home for $200,000 and have a $40,000 down payment, you’ll still owe $160,000. That $160,000 is the principal, and it gets lower each time you make a monthly payment.
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