Important Mortgage Terminology

A Guide to Mortgage Terminology

Shopping for your first home can be really exciting – and also really confusing. One thing that makes it more confusing is all the complicated lingo you’ll hear your real estate agent or loan officer throwing around: DTI, LTV, APR, and so on. Trying to sort out all these initials can feel like swimming through a bowl of alphabet soup.

Here’s a quick glossary to help you out. It covers some of the most important terms you’re likely to hear when you apply for a mortgage – not just what they mean, but why they matter to you as a home buyer.

What It Means: Amortization is the process of paying down the principal on your mortgage loan. When you make a mortgage payment, part of it pays the interest on the loan and part (a small part, at first) goes toward the principal. As your loan gets paid off, or amortizes, the share of each payment going toward the principal gets bigger.

Why It Matters: 

Your lender will give you an amortization schedule showing how each payment you make is split between interest and principal. This schedule shows how fast you’ll gain equity (ownership) in your home. You can also use it to figure out how much money you could save by making extra payments toward the principal.

What It Means: APR is your total yearly cost of borrowing money for a mortgage. The APR factors in interest and other costs, such as broker fees and points (explained below). It’s expressed as a percentage of the loan amount, as in “5 percent APR.” 

Why It Matters: Your APR is the best measure of how much your home loan will cost you over the long term. If you want to compare the total cost of two different loans, look at the APR.

What It Means: Your Debt-to-Income ratio is the percentage of your monthly income you spend on paying off debt. To calculate it, add up the monthly payments on all your debts, then divide the total by your monthly income before taxes.

Why It Matters: When you apply for a loan, lenders look at your DTI to see if you can afford the monthly mortgage payments. Lenders usually consider the ideal DTI, including mortgage payments, to be no more than 36 percent. However, in some cases they’ll consider borrowers with a DTI as high as 43 percent.

What It Means: Your interest rate is the percentage rate your lender charges you each year for a mortgage loan. Like the APR, it’s expressed as a percentage, as in “4.25 percent interest.” However, it doesn’t include the other non-interest costs included in the APR.

Why It Matters: While the APR is useful for calculating the total cost of a loan, the interest rate is what you need to figure out your monthly payment. If you want to compare how much you’ll pay per month on two different loans, look at the interest rate.

What It Means: The ratio of the size of your mortgage loan to the appraised value of the home, expressed as a percentage. For instance, if you take out a $200,000 loan to buy a home worth $250,000, your LTV is 80 percent.

Why It Matters: Lenders consider the LTV when you apply for a mortgage. Generally lenders prefer to accept loans with an LTV of at most 80 percent, but certain loan programs allow for a higher LTV – as much as 90-96.5 percent – as in the case of an FHA loan.  Generally, the lower your LTV ratio, the better the rate for which you qualify. Your LTV also determines whether you need private mortgage insurance (explained below) – with LTV ratios above 80% your lender will likely require you to purchase it. 

What It Means: Points are fees paid up front to the lender at closing. Each point is equal to one percent of your loan amount. There are two kinds of points: discount points, which you pay to get a lower interest rate on your loan, and origination points, which cover the cost of processing the loan.

Why It Matters: Paying discount points up front can get you a significantly lower interest rate. For each point you pay at closing, you can lower your interest rate by around 0.25 percentage points. This, in turn, lowers your monthly payment and overall lifetime loan costs.

What It Means: A pre-qualification letter is a statement issued by the lender, before you start shopping for homes, that outlines the potential amount of a loan you’re likely to qualify for. It’s a useful tool because it gives you a ballpark figure of your price range, and lets sellers know that you’re a serious home buyer. To get pre-qualified, you provide some basic information about your finances – debt, income, assets, and so forth. The lender uses that information to do a high-level evaluation to determine the size of the loan they are likely to approve you for. A pre-qualification does not guarantee pre-approval. In addition, the rate quoted at the time of your pre-qualification may change with the market conditions because it doesn’t get locked in until later in the process. 

Why It Matters: Getting pre-qualified before you start house-hunting helps you figure out which houses are in your price range. That way, you won’t waste time looking at or bidding on houses you can’t afford. However, being pre-qualified is not the same thing as being approved for a home loan. You’ll still have to go through the loan application process when you’re ready to buy.

What It Means: Private Mortgage Insurance (PMI) protects the lender against the risk that you’ll default on your home loan. Lenders usually require PMI on any loan with an LTV over 80 percent.

Why It Matters: PMI can add significantly to the cost of your home loan. Each year, it will cost anywhere from 0.3 to 1.5 percent of your loan balance. The easiest way to avoid this cost is to make a down payment of at least 20 percent.

  Agora Lending is a new type of mortgage lender. We use technology to keep our operational costs as low as possible. From closing costs to interest rates, we made it our mission to make the process of buying a home more streamlined and affordable. Get in touch with one of our mortgage specialists to learn more.