Below is a list of key mortgage terms everyone should know and understand before moving forward with a new mortgage. Refinance or a purchase purchase transaction; it’s important to understand the various terms used before, during and after the process. A borrower with a good understanding of mortgage terms will be in a better position to secure a low interest rate mortgage. For the most up-to-date information on current mortgage rates please be sure to visit our mortgage rates page.
Loan Application – 1003:
This is the official mortgage loan application; established by Fannie Mae that the entire mortgage industry uses. So no matter which lender you chose the loan application will require the same information and generally have the same layout. Within the mortgage industry it’s referred to as the “1003” (ten o three). The loan application is a four page document (some time extension pages are needed when someone owns many properties and/or has lots of creditors) which has the following information:
- interest rate
- transaction and property information
- personal information
- employment and income details
- housing payment
- your current debts
- real estate owned
- disclosure information
Prior to October 2015 the mortgage industry used to issue a “Good Faith Estimate” to disclose the general information about your loan. However after the mortgage crisis the industry looked to simplify the loan disclosure and decided to combine the “Good Faith Estimate” and the “Truth-In-Lending” statement into what’s now called the Loan Estimate.
What is in the Loan Estimate? Just about all the important stuff you need to know about your loan. Interest rate, number of years for your loan term, if the interest rate is locked or not locked, is it a fixed or an adjustable rate, if impounds are being set up, a breakdown of the cash back to you after closing or the amount of money you owe to close. It also has the breakdown of the costs and fees and more.
Doing a mortgage requires the borrower to send in certain documentation. This documentation is then reviewed by the underwriter to see if you qualify for the loan you applying for. Your income, asset and other personal documentation that’s need during the mortgage process. This also might include your insurance declarations page, mortgage statement and other items needed during the approval process. If you own a Condo it would include a copy of your HOA statement and if you own a rental property it would include a copy of your rental agreement.
The loan program is the mortgage loan term and the interest rate structure you chose to move forward with. A 30 year fixed rate; 15 year fixed rate, 7/1 Adjustable Rate Mortgage (ARM), 5/1 ARM etc. These are all known as loan programs. Fixed rate loan programs are terms that have an interest rate and monthly payment that is fixed through out the entire term – your monthly rate and payment never change.
An Adjustable Rate Mortgage has an interest rate that is fixed for a period of time and during the fixed period your monthly payment is fixed as well. After the fixed period of time your interest rate and your payment can adjust. Once they are adjusted the interest rate and payment are fixed for six to twelve months before they can adjust again.
As an example:
If you were to an obtain a 5/1 ARM that would mean your interest rate and monthly mortgage payment are fixed for 5 years (or 60 months) and then your interest rate and payment would adjust. Once adjusted it would stay fixed for one year (12 monthly payments) before it’s next adjustment. It would continue to repeat that until the loan is paid off. Popular Adjustable Rate Mortgage Terms are 5/1, 7/1 and 10/1 ARMs.
HOA stands for Home Owners Association. Usually when you buy or own a Condominium (aka Condo) there is an added expense called a HOA fee. It’s usually paid monthly, sometimes quarterly or ever six months. This is not a lender fee but a fee charged by the Home Owners Association to everyone who owns a home that is covered by the HOA.
What does the HOA due?
A HOA covers the cost of taking care of the community areas and to a certain extent provides limited insurance coverage to home owners (not always though). If you buy a home that has a HOA you required to pay their set fee; it’s not an option.
Debt-To-Income ratio. DTI is very important to the mortgage process and specifically the approval you’ll receive from the underwriter. This is the percentage of a borrower’s income that goes towards paying debts. When an underwriter computes the DTI they include all debts along with the home (property taxes and insurance are factored in). If you own a Condominium or any property that has an HOA fee than that is also added to the calculation.
Principal, Interest, Taxes and Insurance – your total house payment that is used to compute the debt to income ratio.
Discount Points and Origination Fees:
A discount point is a fee charged by the lender to the borrower that is equal to a percent of the loan amount. Discount points are used to obtain a lower interest rate. Sometimes it’s a good idea to pay a discount point (or part of) to obtain a lower rate other times it’s not. One discount point equals one percent of the loan amount. A $250,000 mortgage might have a rate of 4 percent but come with a charge of one discount point, or $2,500, that is paid by the borrower to obtain that interest rate. A lender can charge a partial point (ie 0.25, .50 etc) or a full one, two or more points.
Then there are origination fees. Essentially they work the same way (one point origination fee is one percent of the loan amount) but are charged by the lender to cover their costs for processing and providing the loan. Some lenders don’t charge direct discount points/origination fees and some do. Points do not include all Lender Fees associated with underwriting and processing nor 3rd party fees.
A great question about discount points and origination fees is when should you pay them and how much should you be willing to pay? Every mortgage loan is different but generally speaking unless you are receiving a .25% discount in rate for a half or a full discount point/origination fee than I suggest avoid paying discount points and origination fees.
If you are quoted a 4.50% interest rate with zero discount points/zero origination fees and then also quoted a 4.375% with one discount point it probably makes more sense to go with the 4.50% option. If they offer a 4.25% or a 4.125% for one point then that is something worth considering. You just want to make sure you make up the cost associated with the lower rate in a reasonable amount of time (1-3 years).
Other than discount points and loan origination fees; lenders sometimes charge administrative fees such as underwriting and processing. Some mortgage lenders charge junk fees like “expedited processing” or something similar and those are fees you should avoid paying. But administration and underwriting along with a sub $100 credit report fee are normal fees to pay when you’re refinancing a mortgage or purchasing a home.
Third Party Fees:
These fees include the title, escrow and appraisal fees. While lenders will always require title and escrow services you do have the option to pick your own title and escrow company. All mortgage loans have third party fees. In some cases lenders will cover those fees if you pay a higher interest rate.
As for the appraisal, that is usually handled by a company outside of the mortgage lender and is commonly referred to as an Appraisal Management Company. Payment for the appraisal goes directly to the AMC who locates an appraiser in the area and then the AMC pays the appraiser. At no time during the process can the Loan Officer call the appraiser to try and influence the final outcome of the appraisal report.
Pre-Approval and Approval:
This just means the Loan Officer has reviewed your loan application and the documentation you’ve sent in and based on that information believes you will be approved for a loan. Generally initial interest rates are disclosed along with terms. This is where an experienced Loan Officer can really help. Someone with experience and knowledge about what the loan requirements will be can save you a lot of time and money.
The official “approval” is issued by an underwriter and the underwriter issues a list of conditions with the approval that need to be cleared for the loan to close. Keep in mind that an “approval” is not a guarantee to lend; a lender can reverse it’s decision at any time during the process up until when the loan is actually funded and recorded with the county.
Loan-To-Value Ratio (LTV):
Loan-To-Value ratio is the amount you’re borrowing compared to the value of your home. Along with your credit score this is a big determining factor for the interest rate you qualify for. Your income is also a factor but not necessarily within the confines of the program. If you have low income it will push you to another loan program where as credit and the Loan To Value ratio determine the rate within the loan program.
MI or PMI:
MI is “Mortgage Insurance and “PMI” is Private Mortgage insurance. This is not homeowner’s insurance but an insurance policy you pay in the possible event of default. The payment is every month and is in addition to your monthly mortgage payment. And just to be clear; you do not receive a separate bill for this – it’s included in the same bill as your mortgage payment. So if you default on your loan (miss three or more payments in a row) the insurance company (or federal government in the case of FHA loans) pays the costs associated with foreclosure. MI is for FHA loans and PMI is for conforming loans (and other non-FHA loans) that have a loan-to-value ratio (LTV) above 80%.
Some lenders claim they don’t charge PMI and it appears those loans might be a better deal however usually they are not. What is happening is that you are paying a higher interest rate to cover the cost of the PMI. This is commonly referred to as “Lender Paid PMI”. What’s the problem with that? Simple; once your Loan To Value ratio goes below a certain point you can get rid of Private Mortgage Insurance. However if it’s built into your rate then you are stuck with a higher rate and the same payment. At least with the PMI you can eventually get rid of the monthly cost.
One important note about FHA Mortgage Insurance:
When it comes to FHA Mortgage Insurance you need to refinance (into a non-FHA loan) or payoff the loan to be able to get rid of the monthly MI payment. And there are no lender paid MI options.
This is one of the most important documents during the entire process. You receive the Closing Disclosure (aka the CD) before you receive the loan documents to sign. The Closing Disclosure basically has the same information the Loan Estimate has and then some. The disclosure has a different a different format the Loan Estimate but it’s fairly easy to read. Do you notice how the Closing Disclosure doesn’t have the word “estimate”? That’s because once the CD is issued there can be no added fees to the loan and the fees that are disclosed can not go up. They can go down at closing but not up.
The great thing about the CD is that you get three days to review the document (or more) before you sign your actual loan documents. That gives you the borrower plenty of time to review your closing terms and see exactly what you’re getting in terms of your new loan.
Signing Loan Docs, Funding and Recording:
When your loan is ready to close the lender will send the loan documents to escrow to arrange for a signing. This can only happen three or more days after you’ve received the Closing Disclosure. The signing of the loan documents take place in front of a notary. After the loan documents are signed the loan “funds” which means the lender has wired out funds and requested the title company record the new loan. Recording is when the mortgage is recorded with the county; and the refinance or purchase process is over.