Mortgage terms are like most industry terms: confusing as heck if you’re not in the biz. If you are like most Americans, you’ll need to getahome loan—also known as a mortgage—when you want to buy a home. Paying for a home is a bit more complicated than slapping down a credit card or a pile ofcash.OK, a lot more complicated. But that’s why we’re here—toguide you through those murky financial waters!
We’re decoding the main mortgage terms so you will know what they really mean. If you study up, you can sail through the home-buying process without getting lost in the financial mumbo jumbo.
Down payment
When you and the seller agree to a price, you will need to make a down payment—the lump sum in cash that you can afford to pay at the time of purchase. Traditionally, down payments are 20% of the purchase price, so if you are buying a home for $500,000, your typical down payment would be $100,000. In some red-hot markets, buyers expect higher down payments, sometimes as much as 40%. Don’t have that much money lying around? You might have to do some searching. The days of no-cash-down mortgages are mostly a thing of the past—and for good reason (We’re looking at you, subprime mortgage crisis). You can still find mortgages that require less than a 20% investment, but be warned: You will typicallypay for that privilege down the road with a higher interest rate (see more below).
Principal
Miracle of miracles, you’ve madeyour down payment. Yay! The rest of the money you still owe on your home is called the principal. This mortgage term refers to what you will be paying off, monthly, over the lifetime of the mortgage, which can last anywhere from five to 30 years—usually 30.
Interest
Nothing is free, especially when you are using someone else’s money. Just like your car orcollegeloan, you will pay back the money you borrowed from your lender (most likely a bank) withinterest—a percentage of the principal that you borrowed. Right now, interest rates are hanging around 4% for 30-year, fixed-rate mortgages (more on what that means later).
Fixed-rate mortgage
If you don’tlike surprises—like a sudden jump in your mortgage’s interest rate—thenthis type of mortgage is for you. Once you lock in your interest rate withyour lender, that’s it: The rate remains fixed—your monthly payments will remainthe same for the life of the mortgage. This can be good or bad, but it will always be predictable. While shopping aroundfor the lowest rate, you will notice that interest on fixed-rate mortgages isalmost alwayshigher initially than on adjustable-rate mortgages (seebelow). But over the long run, avoiding the uncertainty of sudden rate hikes might be worth the peace of mind.
Adjustable-rate mortgage (ARM)
This type of mortgagedoes exactly what it says: Its interest rate will be adjusted by thelender in accordance with current interest rates, after an introductory period that could be three, five, seven or 10 years. The good news? The initial ARM interest rate is usually lower than that of a fixed-rate mortgage, and if average interest rates are low, your interest rate and the amount you pay every month will be, too. The bad news? If interest rates go up, well, so does your interest rate and payments, once the introductory period is over. While ARMs make some home buyers leery (they were involved in many of the mortgage defaults of the mid to late 2000s), there are times when it makes sense to get one. And these days, some adjustable-rate mortgages have a cap that limits how high your rate can go, reducing your risk.
ARM caps
If you want an ARM but want to avoid the heart attack that comes withskyrocketing interest rates, you’ll need another mortgage term: a cap. The cap limits how high the bank can nudgeup the interest rate on your loan, thus limiting your monthly payments (and blood pressure). You may pay a bit more for this privilege.
Rate lock
While you are negotiating the terms and conditions of your mortgage—no matter the type—lenders keep reacting to changes in the financial markets bychanging interest rates. So, what looked like a reasonable rate when you submitted your loan application two daysago may no longer look like a deal you can afford. To keep a rate that you like, you will want to lock it in with the bank. A rate lock will remain in effect until closing, but only if you close by an agreed-upon deadline, typically 60 days.
Closing costs
Your down payment isn’t the only chunk of changeyou’ll need to pony up. Whenyou arrive at the closing—the day you sign all the paperwork and the keys exchange hands—you are responsible for payingclosing costs. Those are thevariousfees for the services and processing necessary to make yourmortgage happen. So, bring your checkbook and a decent pen! Youshouldn’t be blindsided by the amount of theclosing costs, because within three days of receiving your loan application the lender mustprovide you with a three-page “loan estimate” that lays out the various fees. While you can’t avoid closing costs,there are ways to reduce them.
Points
Pointsare part of those aforementioned closing costscharged by your lender,calculated as a percentage of the principal. One point equals 1%of your loan (or $3,000 on a $300,000 mortgage), two points equal 2% ($6,000), etc. As you can tell, these are the kinds of points you don’t really want to rack up.But if they can help you clinch the deal onyour dream home, they are so worth it.
