You’re buying a new house from True Homes. That’s awesome. You’re making a great decision! Naturally, the decision to buy a new home is a big step. When it comes to applying for a mortgage, you will be ahead of the game as first-time homebuyers if you learn these key terms of new home financing.
Interest rate. This is the percentage a lender will charge you to borrow the money for buying a home. This is a very important number because even a quarter of a percentage can make the difference in thousands of dollars you pay in interest over the length of the loan. This mortgage calculator demonstrates the difference a lower interest rate can make on both your monthly payment and total amount you’ll pay over time. The lower the number, the better; borrowers who are considered the best credit risk are offered the best interest rates.
In mortgage documents, you’ll see two different numbers — the interest rate on the mortgage and the annual percentage rate, or APR. The APR typically is a little higher than the mortgage interest rate; that is because it includes other fees involved in obtaining your loan. Here is a good explanation of the difference between the two terms.
On a mortgage, you pay more interest at the beginning of your loan because the loan balance (the principal) goes down with every payment. If you can pay a little extra on the principal each month, you could save a lot of money over the life of your loan — and pay it off more quickly.
The interest rate on mortgages can be fixed or adjustable. With a fixed-rate mortgage, the interest rate will always stay the same. With an adjustable-rate mortgage, or ARM, the interest rate can change over time. If you aren’t likely to own your home for very long, it might make sense to consider an ARM. Here is an article about that topic.
Loan term. The term is the length of the loan. Most mortgages are 30- or 15-year terms.
Discount Points. Often, these also are just called “points.” These can be a little complex, but you want to know about them because they could save you a lot of money and make a difference on which lender you choose.
Essentially, discount points are prepaid interest in exchange for a lower interest rate. Most lenders will offer borrowers the chance to buy points. One point costs 1 percent of your total loan and will lower the interest rate by one-eighth to one-quarter of a percent. Here is a good explanation of the pros and cons of discount points.
Discount points benefit banks because they get more money up front. For borrowers, the benefit is a lower interest rate. The tradeoff is having to pay more money upfront. Plus, you need to determine if you’re likely to own the house long enough to benefit from the lower interest rate.
Origination fees. Like everything in business, lenders spend money to make money. In the case of mortgages, they incur expenses when they process a mortgage. Those expenses get passed on to the borrower in the form of origination fees. This fee usually is a percentage of the loan amount, typically .5 to 1 percent of the loan amount. Here is a good explanation of the origination fee.
Appraisal. An appraisal is an educated estimate of the value of the property you want to buy. Lenders require an appraisal of the property so they don’t lend more money than the house is worth. Real estate contracts generally include a clause that says that the agreement depends on the appraisal being equal to or higher than the agreed-upon sale price.
Private mortgage insurance, or PMI. PMI is insurance that protects the lender if you don’t make the payments and the lender has to take back the house. Typically, lenders require PMI if your down payment is less than 20 percent of the appraised value or the sale price of the house. PMI is added on to the monthly payment; it goes away after your payments reach 20 percent of the value of the house.
Closing costs. In the home-buying process, the last step in the process is a meeting called a closing. That’s when you sign all the papers and everyone gets paid. Before the closing, you’ll get a statement called a HUD 1 that lists all the costs and tells you how much money you need to bring to take possession of the house. Closing costs will cover such items as your down payment, document fees, filing the deed, title insurance, the appraisal, closing attorney fees, surveyor fees, etc.
Escrow. You’ll hear this term used in a couple of different ways. The first relates to the purchase contract. When you sign a contract to buy a house, you typically include a deposit, also known as earnest money. That money is deposited in the account of a neutral third party. That keeps your deposit money safe until the deal closes. If for some reason the deal falls through because of something the seller did, you’ll get your deposit back.
Lenders set up escrow accounts to deposit funds from your monthly payments that go to pay homeowners’ insurance and property taxes. That way, you don’t get hit with a big annual bill to pay.
PITI. This is short for principal, interest, taxes, and insurance. Those are the four components of a standard monthly mortgage payment. Over time, taxes may go up or down, depending on the property value of your home and the tax rate assessed by your local government; insurance premiums also can go up or down over time.
This covers the basics, but you might run across other terms that are new to you. At True Homes, we want you to make informed decisions at every step of the process, so don’t be afraid to ask questions if you hear or read something you don’t understand. Your True Advisor is a great resource for you. We’re here to help!