In preparing to buy a home, you start inquiring about mortgage loans and have words thrown at you like DTI ratio, LTV, points, closing costs, escrows, P&I - what do they all mean? This article will help you understand the lingo and tell you what to look for as you research your loan options.
Mortgage Amount or Loan Amount- the actual amount you borrow from the bank to purchase your home. This is also referred to as the Principal amount of your loan.
Term- the time you have to pay back your loan. Most common terms for a mortgage loan are 30 years or 15 years; however, 25-year, 20-year and 10-year loan terms are also available.
Interest Rate or Rate- the percentage rate you will pay back on the principal amount of your loan. This is one of the most important parts of a mortgage loan. You need to know if the rate is Fixed, which means you will have the same rate for the term of the loan, or if it is an ARM. An ARM, adjustable rate mortgage, is a loan that has a fixed rate for a period of time, and then the rate will adjust every year after that period. Common ARM terms are 1/1 ARM, 3/1 ARM, 5/1 ARM and 7/1 ARM. For example, a 3/1 ARM means you have a fixed rate for the first 3 years, and then your rate will change every year thereafter. ARMs are typically considered a riskier loan because you do not know what your rate will be after the fixed-rate period. If your interest rate increases, then your payment will increase. This could put a strain on your budget.
Gross Income - the amount you are paid by your employer before any taxes or benefits are deducted. To figure your monthly income, take your annual salary and divide by 12 (the number of months in a year). If you earn an hourly rate of pay, take your hourly rate X the number of hours you work a week X 52 (the number of weeks in a year), then divide by 12.
Net Income- commonly referred to as bring home pay, which is the money you actually bring home each pay period.
Monthly Liabilities- the amount of your total debt payments you pay monthly. This would include credit cards, auto loans, student loans and any other unsecured debt. Utility bills, day care, groceries, etc. are not considered in this total.
Debt to Income Ratio or DTI- the percentage of your monthly liabilities to your gross income. Add up your total monthly liabilities (including your proposed Total Monthly Mortgage Payment), and divide by your gross income to get your Debt to Income Ratio or DTI. To qualify for a mortgage loan, this ratio should not exceed 45%. Lenders prefer this ratio to be closer to 40%.
Appraisal- a report of your property’s value that is completed by a certified appraiser.
Loan to Value Ratio or LTV- the percentage of what you owe against your home compared to the value of your home. If you take out a mortgage loan for $100,000 and your property is valued at $110,000, then you have a 91% Loan to Value Ratio or LTV.
P&I Payment or Principal and Interest Payment- This is the amount you pay monthly that will be applied to the principal and interest you owe to ensure your loan is paid out over its term.
Escrows- the amount collected from you monthly to pay the cost of your homeowners insurance and property taxes when they are due each year. If you escrow on your loan, you do not make the payment to the companies directly for your property taxes and insurance. Each year when they are due, the bank pays them from your escrow account, which you fund monthly as part of your Total Monthly Mortgage Payment. Escrow is a great option if you are not good at setting aside money throughout the year to cover these expenses or if you like the convenience of not having to worry about these expenses. Plus, you typically pay a slightly higher interest rate or fee if you do not escrow. At closing, you will pay a lump sum for escrow to get the initial funds in place to start your escrow account. This is to ensure you have sufficient funds in your escrow account when your property taxes and homeowners insurance are due.
PMI or Primary Mortgage Insurance- an additional amount you may pay monthly to the bank if your LTV is over 80%. Typically, you will pay this amount until your LTV falls to 80%, at which time it will be removed from your payment.
Total Monthly Mortgage Payment or PITI- your P&I, Escrows and PMI (if applicable) added together. This is the number we discussed in last month’s article that you do not want to exceed 25% of your gross income.
Closing Costs- what it actually costs you to close your mortgage loan. Fees that are typically included are a processing fee, underwriting fee, appraisal fee, flood certification fee, credit report fee, attorney’s fee, title search fee and recording fee.
Prepaids- the amount needed to set up your escrow account at loan closing as well as your odd days interest. Odd Days Interest is the amount of interest due between the date you close your loan and the first day of the following month. This is typically included in what the bank will quote you as “closing costs”; however, it is really just a collection of funds you would have to pay later.
Origination Fee or Discount Points- a fee you can pay to get a lower rate on your mortgage loan, sometimes referred to as buying your rate down. When you get a rate quote from a lender, you should always ask if it includes any origination or discount points.
Mortgage- the document you will sign, which is recorded at the courthouse, to show you owe money against the property. The name of this document varies from state to state. For example, it is called a “mortgage” in Kentucky but is referred to as a “deed of trust” in Tennessee.
Title Search- a search an attorney will conduct on your property to see what mortgages are currently against the home that need to be paid off at closing. It is always important to have a title search completed, even if paying cash for a property, to ensure there are no unknown debts or tax liens owed against the property.
Lender’s Title Insurance- insurance that protects the lender if something comes back on the title to the property. This is typically required on every mortgage loan.
Owner’s Title Insurance- insurance that protects the owner if something comes back on the title to the property. This is an optional insurance and can only be purchased at the time you buy the home.
There is quite a bit of lingo related to mortgage loans. This article should help you with most of the terms you will hear as you navigate the mortgage process. Contact any of our mortgage lenders at Citizens First Bank to discuss all of your mortgage loan options and answer any questions.