Here’s the truth. The process of buying a home includes a lot of unfamiliar words that you’ll probably never need to know again. But as you go through the steps of purchasing a home, this new vocabulary is crucial.
Besides, you’ve already taken steps to improve your finances to put you in a position to buy a house. You’ve automated your savings, built a fund for your down payment and started researching neighborhoods in your city. It’s only fitting that you now learn the lingo so that you are prepared to be a homeowner.
Here’s everything you need to know to sound like a pro and make an informed home buying decision. The best part? We’ve translated this terminology from “finance speak” to plain English.
#1: What is a mortgage?
7-word summary: Legal agreement between you and the lender
Your mortgage is an agreement between you and your mortgage lender. It’s a legally binding way of shaking hands and agreeing to the terms. Lenders are often banks or credit unions, but can also be mortgage brokers or other types of lenders. The mortgage agreement basically states that you are obligated to pay the lender the full amount of the mortgage (plus interest) through a payment schedule.
Your house is collateral for the mortgage. This means that your house serves as a guarantee that you will pay back the lender. If you don’t make your payments, the lender has a claim on the house and will have a way to recoup the cost of the loan. This helps to reduce the risk for the lender.
Mortgages are typically large amounts of money—upwards of $100,000 and often 20 percent of the price of the home.
#2: What is a fixed-rate mortgage?
7-word summary: Same interest rate throughout the mortgage term
Fixed-rate mortgages tend to be the most popular because the interest rate doesn’t change throughout the length of mortgage, which is typically 15 or 30 years.
This means that a fixed-rate loan may be a great option if you want a stable, reliable monthly payment that won’t fluctuate. It feels a bit like renting—you have a set monthly payment and pay the same amount every month until the lease expires.
#3: What is an adjustable mortgage rate?
7-word summary: Fluctuating interest rate throughout the mortgage term
If you don’t have a fixed mortgage rate, then there’s a good chance you have an adjustable mortgage rate, or AMR. These mortgage rates typically have a short-term fixed rate period and then transition into adjustable rates.
An adjustable mortgage rate loan means that the interest rate can fluctuate – some months may be higher than others. This doesn’t mean that you’ll get a daily email with a new rate. Instead, it means that there are preset intervals during which the rate may change for a period of time. As a result, your monthly mortgage payment may change too.
#4: What is private mortgage insurance?
7-word summary: Insurance that provides additional protection for lenders
Also known as PMI, private mortgage insurance is a type of mortgage insurance that not everyone has to pay. PMI is another way that lenders protect themselves from losing money. You’ll typically be required to pay PMI if you have a conventional loan and have less than 20 percent of equity in the home.
Some buyers avoid PMI altogether by making a downpayment that is 20 percent or more of the purchase price. For example, if you buy a home that is $500,000, you’ll need to pay PMI until you have at least $100,000 of equity. You can avoid PMI in this situation with a down payment of $100,000 or more.
#5: What is an appraisal?
7-word summary: Expert opinion about the value of property
An appraisal is basically written evidence that the value of the property is based on fact (and not just what the seller wishes it is worth). Here’s the deal—you’ll probably want to know how much a potential home is worth and lenders definitely want to know what the home is worth.
Sellers list homes for an asking price, but this may or may not be the actual value of the home. There are a lot of factors at play when it comes to determining the value of a property and lenders often require buyers to get potential properties appraised by a professional.
#6: What are closing costs?
7-word summary: Fees and payments for purchasing a home
You probably already know that buying a home is expensive and you might have even heard the words “closing costs” thrown around a few times. Even though this sounds mysterious, closing costs are actually just the fees and payments associated with buying a home.
Here’s what is often included:
- Appraisal fees
- Government taxes
- Title insurance
- Tax service provider fees
- Prepaid expenses like property taxes or homeowners’ association fees
It’s okay if you’re not an expert
As you’ll probably only buy a handful of properties throughout the course of your entire life, it’s okay if you’re not a full-fledged expert on the topic. But even though you may never be an expert, it’s always a good idea to know the basics and feel confident in your decisions. And, keep in mind: the sooner you start preparing to buy a house, the better off you’ll be when the time comes to make an offer.