Your first home is one of the biggest purchases of your life. Be prepared. Know the industry jargon.
Dreaming of your first home is really fun. But there are a lot of steps when you get ready to make that dream a reality. As a first-time homebuyer, the process can be particularly confusing, especially when folks start throwing around industry jargon.
Before you dive into the home buying process, take a moment to familiarize yourself with the common terms you’ll hear. After all, this is probably one of the biggest purchases of your life. It always helps to be prepared.
Credit scores are three-digit numbers generated by a mathematical algorithm using your credit report. In essence, they’re a numerical way of indicating your financial trustworthiness. Scores range from 300 – 850. This number is based on five different criteria: payment history, amounts currently owed, length of credit history, types of credit used, and new credit.
It’s easy to confuse “prequalify” with “preapproved.” They’re similar, in that a lender is defining a base sum you could potentially borrow. However, they are drastically different in one very important way. Prequalifying requires you to submit significantly less documentation. It merely provides a general idea of what size loan amount you might receive.
On the flip side, getting preapproved is a much bigger deal. You have to submit tons of documents, such as pay stubs, bank statements and tax returns. Your loan officer and their team perform an in-depth evaluation of your financial standing and trustworthiness to determine the size of your loan. In essence, a preapproval is a lender telling you just how much money you can borrow to purchase a home – assuming you don’t do something silly like rack up massive credit card bills.
As the name would suggest, with a fixed-rate mortgage your interest rate is fixed throughout the lifespan of your loan. This means that your minimum monthly mortgage payment will remain the same. However, this does not mean that your overall monthly living expenses won’t change. Variables such as taxes, homeowners insurance and PMI (a term we’ll address in a second) could rise or fall. But generally speaking, with a fixed-rate mortgage you’ll know what kind of monthly expenses to expect.
Where a fixed-rate mortgage is predictable, an adjustable-rate mortgage (aka ARM) is not. Depending on your contract, you’ll have a fixed-rate for anywhere from one to 10 years. After that time period, your interest rate will adjust according to a current interest rate determined by the specific index specified in your mortgage agreement. Typically with an ARM your initial monthly fees are less than the fees of a comparable fixed-rate mortgage. However, when your ARM runs out, the size of your monthly payment will vary based on how your interest rate varies.
A conventional loan is not backed by any federal agency. It doesn’t require PMI (that term we’ll address in a second.) However, because conventional loans are not backed by a federal agency, borrowers must have a high credit score and put down at least 20%.
“FHA loans” is short for Federal Housing Administration loans. These loans are backed by the federal government. They are designed to help those with low credit scores and/or small down payments still achieve the dream of homeownership. For first-time homebuyers who haven’t been able to sock away a large lump sum, FHA loans are often the ticket to success.
We told you we’d get here. PMI is private mortgage insurance. It’s a monthly insurance plan that’s applied to all FHA loans. In the same way FHA backed loans protect lenders against a borrower’s potential default, PMI protects the FHA. In most cases, you will be able to drop your PMI once you have achieved 20 percent equity in your home.
An appraisal is an estimate of a property’s worth. If a property is only worth $200,000, lenders don’t want to give you $300,000. Why? Because the property you’re buying is your collateral. If you default on the loan, your lender will recoup their losses by selling your property. If there is a $100,000 difference, it will be impossible for a lender to recoup their losses.
Closing costs are often overlooked by first-time homebuyers, but they’re definitely something of which to be aware. In order to finalize your loan, you’ll need to pay certain fees that will cover items such as lender fees and home inspection. Typically, closing costs run anywhere from 2 – 5 percent of your purchase price.
Points, also known as “discount points,” are fees paid directly to your lender at closing in exchange for a reduced interest rate. You might hear this referred to as “buying down the rate.” By buying down the rate, you lower your monthly mortgage payments.
Points cost 1% of the total amount you borrow. This means a point costs $1,000 for every $100,000. Generally speaking, each point lowers your interest rate by 0.25%. Is it a good decision to purchase points? It depends. If purchasing one point for $1,000 saved you $26.35 a month, you would need to stay in your home for 38 months to break even. Because a 30-year loan lasts 360 months, purchasing points would be a wise move if you plan to live in your new home for a long time. However, if you plan to move within a year or two, you should probably hold onto your cash.
In many ways, escrow is the most confusing terms because in the real estate and lending world it has several different meanings, including:
An impartial third party account that holds your earnest money (the initial check you write when you make an offer on a new home). This third party account holds the money while you and the seller negotiate a purchase price. (Often your real estate agent will have taken care of creating this escrow account.)
A “reserve” account where money for property taxes and homeowner’s insurance is held. (Sometimes your lender will have an in-house department that handles this kind of escrow.)
An action, known as the “closing of escrow.” This is when an escrow officer is called in to finalize the purchase and ensure everyone is paid and the deed is recorded with the county.
Have questions about one of these terms? Contact one of our loan officers today.