When you’re buying a home, the vocabulary alone can be intimidating. Between different mortgage programs, approval, offers and closing, there’s a lot to unpack before you can get to choosing bedroom sets and paint colors even faster. Here, we define some of those confusing terms that go along with the homebuying journey so that you can move through the process more confidently.
Prequalification and Preapproval
You often hear these two terms used interchangeably, but they have slightly different meanings. Think of prequalification as the first step to exploring how much you can afford in a home: you submit your financial information to a lender, and they’ll let you know generally how much you qualify to borrow. Preapproval is the next step up. Instead of taking your word for it that your information is correct, the lender will verify your information, usually with a credit check. This is usually done when you’re ready to put an offer on a home. As a result, your lender can provide a preapproval letter for you to attach with your offer. This shows sellers and sellers’ agents that you mean business, and you’ll be financially able to follow through with your offer.
Debt to Income Ratio (DTI)
Your DTI is a key factor that lenders look at when they’re determining how much you can afford in a loan. Simply put, it compares the amount of money you owe each month – things like car payments and credit card debt – to the amount you earn. Situations vary depending on the individual, but typically a DTI of 36% or below will make lenders more likely to offer financing.
Escrow can apply to a number of different types of contracts, but for the purposes of buying a home, it refers to a third-party account that holds money for one of two reasons: to hold earnest money (essentially a deposit for the purchase) during the buying process or to hold a homeowner’s funds for taxes and insurance throughout the life of a loan.
In the first case, the buyer provides funds to let the seller know they’re intent on making the purchase, and those funds, called earnest money, may be held in escrow until the closing is complete. This third-party account protects buyers in the case that the sale does not go through, allowing the funds to be returned to the buyer.
In the second case, your lender or mortgage servicer may set up an escrow account for you, where your property taxes and homeowners insurance will be held. For the buyer paying the loan, this means that you’ll make one payment to the lender each month, which includes the mortgage payment, taxes and insurance. The lender or servicer will then pay your taxes and insurance out of your escrow count on your behalf.
Fixed Rate and Adjustable Rate Mortgage
Fixed rate mortgages are simple to understand: they simply have an interest rate that stays the same throughout the life of the loan. Adjustable rate mortgages (ARMs) are more complex. They typically start with an interest rate set below a comparable fixed rate mortgage, but that rate might rise over time. It can also lower, though. Both can provide savings depending on a variety of factors. Talk to your lender to better understand these options and which one is best for your particular situation.
Earnest money is essentially a deposit put down by the buyer to hold the home throughout the closing process. It represents a good faith gesture from the buyer to show the seller they’re serious about the purchase. And offering earnest money can often allow the buyer more time to secure financing without losing the purchase. As mentioned above, earnest money will often be held in an escrow account while the sale is pending.
An appraisal is essentially the value of a home, shown in a dollar amount. During the closing process, an appraisal will be ordered, meaning an unbiased third party is hired to look over the property and size up the home’s location, condition and features to the price, to make sure they match up. Appraisers should be licensed or certified, and they can help buyers out a lot by indicating whether or not the home is worth what the buyer is offering to pay. For example, it can be written into your initial buy/sell agreement that the buyer can choose to nullify the agreement if the appraisal comes in under a certain dollar amount. The appraisal process protects the buyer from purchasing a home that’s not worth what they thought it was.
In mortgage lending, amortization refers to the process of paying off your loan. It calculates how much principal and interest you’ve paid against the total amount owed. It also reflects what percentage of each payment is going to what. You typically pay a higher proportion of your monthly payments towards interest early on in the days of paying off your loan. As each mortgage payment passes, more and more from each month goes to the principal as well.
A RMCU, our local mortgage lenders are happy to help answer any questions you have about the homebuying process. And, when you’re ready, they’ll work with you to understand what you’ll prequalify for in a home so that you can start looking for a place of your own. As a first step, download our home mortgage checklist to make sure you have everything you need before talking with a lender.
If you enjoyed this blog, you might enjoy these other related blogs:
- How Do You Know When You're Ready to Buy A Home?
- Is Buying a Tiny House Worth It?
- 3 Tips For Buying a Home
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