10 Essential Mortgage Terms Every First-Time Homebuyer Should Know

Purchasing your first home is exciting and signifies entering a new chapter in your life.

As you navigate the homebuying process, you’ll encounter plenty of jargon that’s confusing, if not downright intimidating, when it comes to understanding mortgage terms.

Thankfully, we’re here to make 10 of the most critical mortgage terms digestible and easily understood.

Here Are 10 Essential Mortgage Terms First-Time Buyers Must Know

#1. Earnest Money

Also known as a “good faith deposit,” earnest money can be used to show a seller you’re ready and willing to purchase in their property listing. Earnest money is a financial deposit that the buyer gives to the seller when they submit their initial purchasing offer. Typically, the earnest money is a down payment totaling up to 10% of the offer price.

Earnest money is used to show sellers you’re serious, financially prepared, and eager to move forward. First-time homebuyers can consider offering earnest money to make their offer on the home more appealing and likely to be accepted.

#2. Debt-to-Income Ratio (DTI)

Your debt-to-income ratio is easily calculated by taking all your monthly debt payments and then dividing them by your gross monthly income (what you take home before deductions and taxes).

Mortgage lenders use this calculation to ensure you have enough income to manage the monthly payments on the mortgage you intend to take out.

#3. Escrow

Unsurprisingly, buying a home comes with a lot of expenses like property taxes, homeowner’s insurance, earnest money, and more. Where is all that money stored during the buying process? In an escrow account.

Escrow is the legally-binding arrangement where a third-party holds onto this money until the purchase agreement has been satisfied. Usually, the escrow account is set up by your mortgage lender. In the event your lender doesn’t have an escrow account, the responsibility of paying home buying expenses falls to you.

Not only does an escrow account protect you by keeping your money safe and ensuring it goes to the right place after closing, it also allows you to make payments over 12 months, rather than all at once.

#4. PITI

This term is an acronym for what makes up your mortgage payment:

• Principal: The total amount borrowed for your mortgage.
• Interest: The interest charged on your mortgage loan.
• Taxes: The amount of property taxes owed.
• Insurance: The cost of homeowner’s insurance premiums.

#5. Private Mortgage Insurance (PMI)

If a first-time homebuyer doesn’t have the 20% for a down payment on a home, they are required to get private mortgage insurance, or PMI.

This coverage is specifically needed to protect the lender from loss if whomever borrowed stops making payments on the loan. Once at least 20% equity is achieved in the home, you can then choose to remove private mortgage insurance, bringing your monthly costs down.

#6. Underwriting

Mortgage underwriting describes the process mortgage lenders use to understand and assess the risk they could take by lending to a borrower.

During the underwriting process, mortgage lenders will review characteristics that could influence this risk, such as:

• Your credit score
• Your income
• Your amount of debt
• The price of the property you want to purchase

#7. Term Length

The term length is the number of years it takes to pay off a loan. The loan term determines the monthly payment amount, repayment schedule, and total interest paid.

While you can find mortgages with varying term lengths, the most popular are 30 years and 15 years.

#8. Amortization

Amortization is the process of paying off debt in equal installments over time. When you take out a home loan, you’ll make regular monthly payments that follow an amortization schedule.

The schedule will dictate how much of your monthly payment goes toward principal and interest each month. In the beginning of the loan term, more of your monthly mortgage payment goes toward interest.

#9. Annual Percentage Rate (APR)

Your annual percentage rate, or APR, is the annual cost of borrowing money from your lender shown in percentage form. Your APR includes the interest rate of your loan, along with the other fees that come with taking out your loan.

Comparing APRs can be helpful when shopping for a lender and comparing mortgages because it provides a more holistic view of the true cost of your loan, rather than just the interest you’ll accrue.

#10. Discount Points

Did you know you could pay to get a discount on your mortgage?

Also known as mortgage points, discount points are an optional fee you can pay to your lender to lower the interest rate on your mortgage loan. Usually, one discount point will cost you 1% of your total loan amount.

Let’s say you take out a mortgage for $350,000. This means purchasing one point will cost you $3,500. In turn, your interest rate will be reduced by a percentage point determined by your lender. Keep in mind the discount by point you’ll get varies from lender to lender, though usually you can expect a .25% reduction in your interest rate for each point you buy.

Purchasing discount points is actually pre-paying your interest, with discount points costs paid at closing.

Ready for more mortgage must-knows? Don’t be intimidated as a first-time homebuyer — we’re here to help. Find a top agent today that can walk you through the transaction process through RealEstateAgents.com!