Eight mortgage terms you need to know before applying for a mortgage
Getting a home mortgage can be challenging for new home buyers as it includes multiple documentation, bank statements, tax returns, phone calls, credit scores, etc. So, it is crucial to understand the mortgage process and related terminologies that can simplify the transactions. Here are the eight most commonly used mortgage terms for your perusal.
Amortization is the division of a loan into a series of fixed payments. These payments are then spread over time (usually in months) to create monthly payments. Also, these monthly installments include both the principal loan and interest rate provided by the lending institutions.
Most of your payment will transfer to interest at the start of the mortgage process. However, as you continue making payments, more will go towards your principal loan.
2. Loan-to-Value Ratio (LTV)
When you begin the home loan process, you will hear one common mortgage term: loan-to-value or LTV. It is the ratio of the home loan to the home value.
For example, if you want to buy a house for $400,000, you only need to borrow $200,000, and your LTV is 50%.
Many lenders use LTV as a standard calculation method for making underwriting decisions. More so, the LTV ratio helps the lender to determine the risk associated with the loan.
A lower LTV ratio indicates that the borrower has a higher down payment and thus reduces the lender’s risk. Mortgages with a high LTV ratio are considered higher-risk loans. Financial institutions that issue mortgages prefer lower LTVs, as higher LTV will result in higher interest rates.
There are two definitions of escrow that you need to understand when purchasing a home. The first one is the escrow method that describes the process of a sales agreement. The neutral party like escrow company and attorney handles the mortgage process to secure buying and selling transactions.
The second definition deals with an escrow account. The escrow account is a third-party account that first assesses your family insurance and annual tax charges. Then, after careful assessment, you will be required to pay a portion of the tax and insurance along with interest and principal loan every month.
For example, if your monthly mortgage is $1,409, then the principal and interest payments might be $1012, while $330 for sales tax and $67 for insurance.
4. Loan Estimate
Loan estimation is the crucial home mortgage term representing the disclosure of the total loan cost by the lender. It is an easy-to-read document that contains information about your interest rates, transaction costs, and monthly payments. The lending company will provide you the disclosure statement within three days of the application. The real estate loan evaluation will help you compare the mortgage quotes of different companies and choose the right loan according to your situation.
5. Closing Disclosure and Settlement Statement
When completing the transaction process, the borrower will receive two documents: the final disclosure and the other settlement statement. These disclosures list all paid and received funds, including escrow deposit amounts paid for property taxes, mortgage loans terms, and risk insurance. Furthermore, these documents also contain specific information about your home loan, such as monthly installments, credit history, etc. Visit a rate checker.com for more details.
6. Principal and Interest
The principal is the amount you received for the home loan. The borrower will pay this money to the lender at the end of the payment agreement. The rate of interest is what the lender costs you to loan money.
As you pay the loan, the principal owned by your lender decreases, but the interest payment will remain the same. Principal and interest may account for most of your monthly payments, but keep in mind that your mortgage payments may also include taxes and insurance.
7. Total Debt Ratio
Another important home mortgage term is the total debt ratio, used to determine the type of housing you can afford. This ratio calculates debt and housing payments divided by total monthly income. The lending companies use TDR (Total Debt Ratio) to determine the risk associated with house mortgages. The total debt ratio helps the owners in deciding the type of loan they will secure.
The better your index is, the more favorable the loan you will get. Therefore, higher income or lower debt will reduce the credit risk of the lender. Your mortgage specialist will assist you in developing a new plan if your total debt ratio is high so that you can claim your dream home.
8. Mortgage Insurance Premium (MIP)
Mortgage Insurance Premium is insurance that the borrower pays to the lender when the down payment is lower than the traditional 20%. It is referred to as a premium for loan payment because it protects the lender in default cases. The mortgage insurance (MIP) can help first-time homebuyers who do not have an initial 20% down payment.