Key Mortgage Terminology To Know

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Understanding mortgage terminology is essential when financing a home purchase. But becoming fluent can be like learning a new language. Here’s a comprehensive guide to key mortgage-related terms, from A(PR) loans to V(A) loans, to help demystify the intricacies of mortgage lending.

Main conditions of a mortgage

Adjustable Rate Mortgage (ARM)

An adjustable-rate mortgage is a mortgage where the interest rate on your loan changes at predetermined times, up to every six months. There is usually an “introduction” period during which the interest rate is especially low — even lower than a fixed-rate mortgage — before the interest rate increases or decreases depending on market conditions.

Amortization

Amortization refers to the process of paying back a loan, such as a mortgage, in installments over a period of time. Part of each payment goes toward the principal (the amount borrowed), and the rest goes toward interest. A typical mortgage is amortized over a 15 or 30 year period, with the amounts allocated to interest and principal decreasing and increasing, respectively, over time. When a loan is fully amortized, or reaches maturity, it means that it will be completely paid off by the end of the amortization schedule.

April

The Annual Percentage Rate (APR) reflects the borrowing cost of a mortgage. A broader measure than just the interest rate, the APR includes interest rates, discount points, and other fees associated with the loan. The APR is higher than the interest rate and more accurately represents the actual cost of a loan.

Balloon Mortgage

Balloon mortgages are short-term home loans, usually spanning five to seven years. With these non-conformed loans (see Non-conformed Loans below), borrowers make relatively small monthly payments for a set period of time. Then, at the end of the loan term, they pay the remaining balance in a lump sum, meaning your payments suddenly balloon (hence the name). These payments can be quite large, making them very risky.

Cash-out refinancing

A cash-out refinance is a type of mortgage that allows you to take out a portion of your home’s equity in one lump sum. The process involves taking out a second, larger mortgage to replace your first mortgage. The new loan will include the outstanding balance of your first mortgage plus the cash you withdraw, and will have a new interest rate and term.

Closing costs

Closing costs are fees associated with obtaining a mortgage. They include several expenses such as loan fees, appraisal fees, credit report fees, and title search fees that are paid at the time of signing or settling on the loan. Both the home buyer and seller pay for closing costs. Many of them are often paid by the buyer, but sometimes the seller pays some of those costs.

Conforming Loan

A conforming loan is a mortgage that meets the guidelines and loan limits set by the Federal Housing Finance Agency (FHFA). The guidelines include a borrower’s credit score, debt-to-income ratio, and down payment requirements. Loan limits change annually and vary by county, but they dictate the maximum loan amount that government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac will purchase or guarantee. Following these guidelines allows lenders to sell these loans to Fannie Mae and Freddie Mac, reducing their risk and allowing them to offer better terms to borrowers.

Construction Loans

A construction loan is a type of short-term loan, usually with a one-year term, used for the specific purpose of building a home. With this type of loan, you withdraw funds at predetermined stages of the project. There are two main types of construction loans: construction-only loans and construction-to-permanent loans. Construction-only loans must be paid back once the home is completed (or are rolled over into a traditional mortgage). Construction-to-permanent loans convert into a mortgage once the home is completed.

Conventional Loans

A conventional loan is a mortgage that is not guaranteed by the government and is funded entirely by the private sector. Unlike FHA, VA, or USDA loans, which are insured or guaranteed by a federal agency, conventional loans are guaranteed by the lender that issues the loan. Conventional loans used to require a 20 percent down payment, but there are now loans that allow for less, but often still require private mortgage insurance (PMI).

Debt-to-Income Ratio (DTI)

Debt-to-income ratio (DTI) is a measure of a borrower’s ability to repay a mortgage and is calculated by adding up all of a borrower’s monthly debt payments and dividing that total by the borrower’s gross monthly income. For example, if a borrower’s monthly debt payments are $4,000 and their gross monthly income is $10,000, their DTI ratio is 40 percent.

down payment

A down payment is the amount of the home purchase price that a homebuyer pays up front in cash. Paying a larger down payment increases the chances that a borrower will qualify for a lower interest rate. Different types of mortgages have different minimum down payments.

Deposit

An earnest money deposit is a security deposit paid by a home buyer when signing a home sales agreement (PSA) and is commonly used as a sign of good faith. The deposit is usually held in an escrow account by the title company. If the home purchase agreement closes, the deposit can be used toward a down payment or closing costs. If the purchase agreement does not close, the deposit is returned to the buyer or seller, depending on whether the PSA allows for a reason to terminate the contract.

Fairness

Equity is the percentage of your home that you own outright. It represents the portion of your home that you’ve paid off in full (and/or put a direct down payment on). For example, if your home is valued at $300,000 and your mortgage balance is $100,000, your equity is $200,000. You can borrow against the equity in your home to get cash quickly.

escrow

An escrow account (also called a custodial account) holds the portion of a borrower’s monthly mortgage payment that goes toward homeowner’s insurance and property taxes. An escrow account also holds earnest money that a buyer puts down after accepting an offer and before closing. Insurance and tax escrow accounts are usually set up by mortgage lenders or servicers who make insurance and tax payments on behalf of borrowers. This system allows lenders to ensure these bills are paid.

FHA Loans

An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). This means that the FHA guarantees it, and if you default, the FHA will reimburse the lender, reducing the lender’s risk. As a result, FHA loans often have looser credit requirements and smaller down payments than conventional loans, making them especially popular with first-time homebuyers.

Fixed Rate Mortgages

A fixed-rate mortgage is a loan whose interest rate stays the same for the entire repayment term (the life of the loan). In contrast, an adjustable-rate mortgage’s interest rate fluctuates based on market conditions. Borrowers can only change the interest rate on a fixed-rate mortgage by refinancing.

Patience

A grace period is a short-term suspension of mortgage payments, usually due to financial hardship. Once the grace period ends, homeowners can pay off their missed payments in a lump sum, set up a repayment plan, or apply for a loan modification.

Seizure

A foreclosure occurs when a homeowner stops making payments on their mortgage. This default allows the lender to take possession of the home since the home served as collateral for the loan. A foreclosure allows the mortgage lender to sell the home and recoup what is owed.

Homeowners Insurance

Homeowners insurance protects the policyholder’s home and personal belongings in the event of unexpected damage or destructive events (fire, hurricanes, etc.) or theft. Homeowners insurance covers the repair of residential property, including detached buildings such as garages, sheds, and pool houses, as well as liability for injury to individuals and their belongings on the premises. Homeowners insurance is not required by law, but lenders typically require borrowers to purchase homeowners insurance as a condition of a mortgage.

interest rate

A loan interest rate represents the interest rate that a lender charges a borrower. It is expressed as a percentage that is applied to all mortgage payments. The interest rate a lender charges reflects general market trends, but also how risky the borrower is. Interest rates on short-term loans are often lower than long-term loans (because lenders can pay the money back faster), and people with good credit scores tend to qualify for lower interest rates than applicants with poor credit histories.

Jumbo Loan

Jumbo loans are mortgages for larger, more expensive properties. Jumbo loan amounts are higher than the general mortgage standard set by the federal government (called the “conforming loan limit”). Most mortgages fall within this conforming limit, which is adjusted annually. This means that banks can only lend a certain amount based on the geographic area where the home is located. In most parts of the US, the limit is $766,550, but in the most expensive areas, the conforming loan limit is $1,149,825 (2024). If you need more than that, you’ll need a jumbo loan.

Loan Estimate

A Loan Estimate is a three-page document that details your mortgage. It is given to potential borrowers within a few days of application and includes an estimate of the loan interest rate, monthly payments, total closing costs, escrow fees, prepayment penalties, and other related fees. The Loan Estimate is designed to make it easier for borrowers to compare terms when searching for a mortgage, since all lenders use the same standard form. Receiving a Loan Estimate does not determine whether you will be approved or denied for a loan.

Loan-to-Value Ratio (LTV)

The loan-to-value ratio (LTV ratio) compares the mortgage amount to the value of the property. An LTV ratio of 80 percent or less (equivalent to a 20 percent down payment) is the traditional standard for conventional loans. If your LTV ratio is more than 80 percent, you must purchase mortgage insurance, which comes at an additional cost. Some government mortgages, such as FHA and VA loans, allow higher LTV ratios and may or may not come with a requirement for mortgage insurance.

Mortgage Broker

A mortgage broker is an intermediary who matches prospective buyers with mortgage lenders, such as banks, credit unions, and other financial institutions. Buyers often seek a mortgage broker’s assistance in finding the best loan for their situation and the lowest interest rate available. Working with a mortgage broker can simplify the process of looking for and comparing loan offers. In addition to helping home buyers find a mortgage, brokers often communicate with all parties involved in the lending process to ensure that applications are filled out and submitted correctly, and that loans are closed on time.

Mortgage Insurance

Mortgage insurance is typically required for mortgages where the buyer puts down less than 20 percent. The insurance is paid by the borrower, usually as part of the monthly mortgage payment. This extra fee acts as protection for the lender if the borrower defaults on the loan and helps them recover their funds. There are two basic types: Private Mortgage Insurance (PMI), which is charged on conventional loans, and Mortgage Insurance Premium (MIP) on FHA loans.

Non-QM Loans

A non-QM loan (short for non-qualified mortgage) is a type of mortgage that does not meet the standards set by the Consumer Financial Protection Bureau (CFPB). These loans are intended to provide a financing option for borrowers who don’t meet traditional income, financial, or credit standards, but can demonstrate their ability to repay the mortgage through alternative means. Because non-QM loans are riskier for lenders, they often come with different terms and higher interest rates than regular mortgages.

Notice of Default

A Notice of Default is a formal document that a lender files with the court when a borrower is behind on their monthly mortgage payments. The document usually includes the borrower’s name, address, lender’s name, and mortgage information. A Notice of Default is usually a precursor to foreclosure, which is the first step in the foreclosure process.

commission

Origination fees are charged by lenders for originating, processing, and underwriting the loan. In most cases, mortgage origination fees are between 0.5 and 1 percent of the total loan amount and are due at closing.

Had to

PITI stands for the four main components of a mortgage payment: principal, interest, taxes and insurance. The first two are the portions of the payment that cover the principal, or amount borrowed, and interest, both of which are paid to the lender as payment on the loan. The other portion covers property taxes and homeowner’s insurance, and is usually deposited in an escrow account.

point

Borrowers can purchase discount points (also known as mortgage points) to lower the interest rate on their loan. Typically, one point is one percent of the loan amount and lowers the interest rate by .25 percent (but this can vary by lender). The cost of the points is included in the loan quote and the borrower pays it at closing. Generally, borrowers purchase points to lower their interest rate over the life of the loan, so purchasing points may only be worthwhile if the borrower plans to live in the home long enough to offset the upfront cost.

Pre-approval

Pre-approval is a status a borrower receives from a mortgage lender, indicating that they are willing to provide a specific amount of money for the purchase of a home. This does not mean that the borrower is guaranteed the loan, but it indicates that the borrower is in a favorable position to obtain a loan (which can be proven to the seller in the form of a mortgage contract). It is issued after the lender has run a credit check and collected financial information about the borrower.

Pre-qualification

Pre-qualification for a mortgage requires sharing basic personal information with a lender. In return, the lender provides the prospective borrower with an estimated loan amount and interest rate. The pre-qualification process is less complicated than the pre-approval process, and being pre-qualified doesn’t guarantee that a borrower will be approved for a specific loan amount or interest rate — that is, it’s under no obligation on the part of the lender. Pre-qualification usually involves a soft credit check and doesn’t require a formal application.

Major

The principal of a mortgage is the amount that you initially borrow from a bank or lender, known as the loan amount. Interest, on the other hand, is the amount that the lender charges you for the money you borrow. Your monthly mortgage payment is made up of both principal and interest payments.

Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is a type of insurance that borrowers must buy when they put down less than 20% on a conventional loan. PMI protects the lender (not the borrower) from loss if the borrower stops making payments on the loan. When refinancing, PMI is required if the borrower’s home equity is less than 20% of the property’s value.

Rate Lock

Interest rates change rapidly, but a rate lock helps ensure that a borrower’s mortgage rate remains the same from initial application to closing. This lock helps protect the borrower if interest rates rise. Lenders will lock in a mortgage rate for a set period of time, usually between 30 and 120 days. The length of time varies by lender.

Refinancing

A borrower who already has a mortgage can refinance into a new loan with a different interest rate, term, or both, and then pay off the existing loan with the new loan. The borrower does not have to refinance with the same lender who has their current mortgage.

One common reason for refinancing is to lower your interest rate. This is usually because economic factors have caused interest rates to fall or because the borrower’s credit has improved. Borrowers may also refinance to shorten their loan term, pay off their mortgage sooner, and reduce the total amount of interest they pay overall.

Reverse Mortgage

Reverse mortgages are available to homeowners of a certain age (usually age 62 or older, but up to age 55 for some loans) who have paid off all or most of their mortgage. In this arrangement, the lender makes monthly payments to the homeowner. The homeowner borrows their own funds in cash. The payments are tax-free and can be interest-free (meaning the borrower does not have to make payments in their lifetime). If the borrower dies, sells, or leaves the home permanently, the lender either gets paid back or owns the home.

Short selling

In a short sale, the lender allows the borrower to sell the property for less than the remaining balance of the mortgage. The lender then forgives the difference between the original loan and the sale price of the home. Borrowers who are significantly overindebted on their home (i.e., they owe more on it than the home is worth) may choose a short sale to avoid foreclosure. However, this action can have a negative impact on the borrower’s credit for several years.

Title Insurance

Title insurance protects both the home buyer and the mortgage lender. It protects both the buyer and the mortgage lender from unforeseen problems such as title disputes, liens, and other legal claims resulting from the actions of previous owners. If a dispute arises during or after the sale, the title insurance company may be liable to cover certain legal damages. Lenders often require title insurance as a condition of issuing a mortgage to a borrower.

underwriting

Mortgage underwriting is the process by which a bank or mortgage lender evaluates the risk they take on by lending to a particular borrower. The underwriting process takes into account factors such as the borrower’s credit report or credit score, income, debt, and the value of the property they plan to purchase. Many lenders follow standard underwriting guidelines from Fannie Mae and Freddie Mac when deciding whether to approve a loan.

USDA Loans

USDA loans (also known as Rural Development loans) are offered to people who want to buy a home in certain rural areas. They are issued by private lenders and guaranteed by the United States Department of Agriculture. USDA loans offer generous terms (for example, no down payment required), but applicants must have a low or moderate income.

VA Loans

VA loans are guaranteed by the U.S. Department of Veterans Affairs. Active-duty military and veterans, as well as surviving spouses, are eligible to apply. VA loans are attractive because they require no down payment, have no loan limit, and can be 100% funded (assuming the borrower is fully qualified).

Additional reporting by Jess Ulrich