The ABCs of Mortgages

Read Time: 2min
Last Updated: 5/25/2022

Like any industry, the mortgage world has its own alphabet soup of terms. Here are short, succinct descriptions of the most-used phrases and keywords, as well as links to more information on each.

Adjustable-Rate Mortgage (ARM): A mortgage that doesn’t have a fixed interest rate. With ARMs, the rate changes during the life of the loan based on movements in an index rate, such as Treasury securities, or the Cost of Funds Index. ARMs usually offer a lower initial interest rate than fixed-rate loans.

APR (Annual Percentage Rate): The rate of interest that will be paid back to the lender; this may be fixed or adjustable.

Appraised value: The estimated value of a home used during the sale process. A professional appraiser will determine the amount, which is used in connection with a loan.

Assessed value: The value of a home determined by the public tax assessor. This value dictates property taxes and will change over time.

Closing costs: All loans have closing costs you normally pay upfront and they usually vary from 3% – 6% of the loan amount depending on your situation.

Credit score: A number that reflects a person’s history with debt and is used to predict the likelihood they’ll repay a loan. The higher the score, the more likely the person is to secure a loan, and a lower rate.

Debt-to-income ratio (DTI): A percentage lenders use to determine a loan’s risk. Lenders compare the potential buyer’s monthly payments – including the new mortgage – to their monthly income.

Discount points: Also called “points” or “mortgage points,” these are fees used to buy down an interest rate. The homeowner pays more in closing costs in exchange for smaller payments over the loan’s life. Each discount point costs 1% of your loan size, and it typically lowers your mortgage rate by about 0.25%.

Down payment: The amount of the purchase price the buyer pays upfront. Lenders usually require a down payment, but there are some federal government loans that may not need one.

Escrow: An account managed by the lender that holds a percentage of the home’s yearly taxes. Buyers set this aside at closing.

Loan-to-value ratio (LTV): This measures the appraised value of a home against the loan amount. LTV helps lenders determine how much risk they’re taking on; a good LTV is usually 80% or lower.

Fixed-rate mortgage: A home loan with a predetermined fixed interest rate for the entire term of the loan.

Pre-approval: A lender’s conditional agreement to lend a certain amount to a buyer—if certain terms are met.

Pre-qualification: A lender has decided the buyer will likely be approved for a loan, based on their financial situation. It’s an early step in the process.

Private Mortgage Insurance (PMI): Insurance designed to protect the lender in case the buyer defaults on the loan. Typically, this is required when the buyer puts down less than a 20% down payment.

Underwriting: The lender verifies the buyer’s income, assets, and debt to determine if a loan will be approved. An underwritten pre-approval shows that the lender has determined the buyer is qualified to make the purchase.

Want to dig deeper? Investopedia offers a wealth of articles, insights, and updates.

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