Back to School…Mortgage Addition
Thanks to school, you’ve learned the ABCs of the English language. But what about the ABCs of mortgages? From amortization to prepaids, we define the important pieces of information you need to know before choosing a mortgage loan.
Amortization
Amortization refers to the process of paying off a debt through scheduled, predetermined installments that include principal and interest.
Annual Percentage Rate
APR is the yearly interest generated by a sum that’s charged to borrowers or paid to investors. APR is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan or income earned on an investment.
Appraisal
An appraisal is the estimation of a home’s current market value. A licensed appraiser completes an unbiased, professional estimate that’s calculated by current market trends and compares the recent sales of similar properties in the area.
Assets
Assets include checking and savings accounts, 401(k) and IRA accounts, certificates of deposit (CDs), stocks, bonds, and mutual funds.
Closing Costs
Closing costs are the fees associated with the sale of a home that are paid at closing. This can include title insurance, lender fees, appraisal fees, and more. Closing costs are typically 2%–5% of the property’s purchase price.
Discount Points
These are optional closing costs you can pay to “buy” a lower interest rate. One discount point is equal to 1% of your loan amount. The more discount points you buy, the lower your interest rate will be. However, if you buy more points, you’ll need to cover them in cash at closing. You’re essentially paying more up front to have more savings over the life of the loan.
DTI Ratio
Debt-to-income ratio measures the ability of an individual or entity to pay back their debt or installments easily without any financial struggle. It’s expressed as the ratio of the monthly debts people need to pay to the gross income they make every month. Total debts/total assets = DTI ratio.
Escrow
An escrow is a legal arrangement in which a third party temporarily holds large sums money or property until a particular condition has been met (e.g., the fulfillment of a purchase agreement). After you purchase a home, you’ll be responsible for maintaining insurance on the property and paying state and local property taxes. The property tax and insurance premiums you owe are the escrow payments made to your escrow or impound account.
FHA Loan
An FHA loan is a mortgage backed by the Federal Housing Administration. Since these mortgage loans are insured by the federal government (and are less of a risk for lenders), they can be easier to qualify for if you’re rebuilding your credit or if you need to make a smaller down payment.
FICO Credit Score
A FICO score is a three-digit number between 300 and 850 that tells lenders and other creditors how likely you are to make on-time bill payments. This helps lenders evaluate the level of risk you pose as a borrower and lets financial institutions, insurance companies, and other entities make faster decisions regarding your credit worthiness. There are five factors that make up a credit score: payment history or any late payments (35%), amounts owed or outstanding balances (30%), length of credit history (15%), new credit or opening new accounts (10%), and credit mix or revolving lines of credit/installment loans (10%).
HOA
An organization in a subdivision, planned community, or condominium building that makes and enforces rules for the properties and residents. Those who purchase property within an HOA’s jurisdiction automatically become members and are required to pay dues, which are known as HOA fees. Some associations can be very restrictive about what members can do with their properties while others may give residents more freedom.
HOI
Homeowner’s insurance is required for all borrowers getting a mortgage. HOI policies protect you and your lender against specific dangers (like fires or tornados) to your home so you and the lender can recoup the value shared in it. HOI also covers both liability insurance (needed if someone were to be injured on your property) and homeowner’s insurance (needed to cover the home from damage). HOI can also refer to the Housing Opportunity Index, which is the share of homes sold in a certain area that would have been affordable to a family earning the local median income based on standard mortgage underwriting criteria. The HOI is released every three months and calculated using two major components: income and housing cost.
HELOC
A home equity line of credit (HELOC) is a revolving line of credit, usually with an adjustable interest rate, which allows you to borrow up to a certain amount over a period of time. HELOCs work like credit cards in that you can continuously borrow up to an approved limit while paying off the balance.
LTV
A loan-to-value ratio measures the relationship between the loan amount and the market value of an asset, such as a home or car. It’s used by lenders to assess the risk of lending money and to determine the percentage of the asset’s value that they’re willing to finance. A lower LTV means less risk for the lender and more chances of getting a better mortgage for the borrower. LTV is calculated by dividing the loan amount by the appraised value of the asset.
Per Diem Interest
This is the interest charged on a loan at a daily rate. It covers the period between the closing or refinancing date and the day before loan repayment begins. It may apply when a borrower makes a payment earlier than the expected date, reducing the principal more than the monthly interest rate.
PMI
Private mortgage insurance is a policy that protects the lender against any losses if the borrower stops making payments or fails to repay their conventional loan. Borrowers who purchase a home with less than a 20% down payment are typically required to pay for private mortgage insurance. However, it can be removed once you reach 20% equity in your home.
PITI
Principal, interest, taxes, and insurance—these four components make up your monthly mortgage payment.
Prequalification
Prequalification for a mortgage is documentation showing you’re a good candidate for receiving a home loan. To get prequalified, you’ll complete an application, and the lender will review your financial information, including your credit, income, assets, and tax returns. Prequalification tells you which types of loans you may be eligible to take out, how much money you may qualify to borrow, and what interest rate you may be able to secure. However, prequalifying does not mean you’ll automatically secure a loan for any home you want.
Prepaids: Escrows, Taxes, Insurance, Per Diem Interest
This includes the costs for the home’s property taxes, homeowner’s insurance, HOA dues, and per diem interest due at closing. When purchasing or refinancing a mortgage home loan, there are closing costs and prepaids. Closing costs are fees incurred for purchasing the property, and prepaids are costs incurred for home ownership.
Mortgages loans can feel overwhelming at first. However, by learning the ABCs of mortgages, you can walk into your local Union Savings Bank confident in your financial literacy. Visit or contact our loan officers today to get started.
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