Understanding mortgage terminology is essential when buying a home. This comprehensive glossary covers loan types, key concepts, costs, and the mortgage process to help you make informed decisions.
19 terms defined
A conventional loan is a mortgage not insured or guaranteed by a government agency. Conventional loans typically require higher credit scores (620+) and larger down payments, but offer competitive rates and the ability to remove PMI once you reach 20% equity. They can be conforming (meeting Fannie Mae/Freddie Mac guidelines) or non-conforming.
A jumbo loan is a mortgage that exceeds the conforming loan limits set by the Federal Housing Finance Agency (FHFA). These limits change over time and can be higher in expensive markets. Jumbo loans typically require higher credit scores (700+), larger down payments (10-20%), and more reserves.
An adjustable-rate mortgage (ARM) has an interest rate that changes periodically based on market conditions. ARMs typically start with a lower fixed rate for an initial period (5, 7, or 10 years), then adjust annually. A 5/6 ARM means 5 years fixed, then adjusts every 6 months. ARMs have rate caps limiting how much the rate can increase.
A fixed-rate mortgage has an interest rate that remains constant for the entire loan term, providing predictable monthly payments. Common terms are 15-year and 30-year fixed. The rate never changes regardless of market conditions, protecting borrowers from rate increases but also meaning they cannot benefit from rate decreases without refinancing.
A conforming loan meets the guidelines set by Fannie Mae and Freddie Mac, including loan limits that change over time and can be higher in expensive markets. Because these loans can be sold to government-sponsored enterprises, they typically offer lower interest rates than non-conforming loans. Conforming loans have standardized requirements for credit, DTI, and documentation.
The Annual Percentage Rate (APR) represents the total yearly cost of borrowing, including the interest rate plus fees, points, and other charges expressed as a percentage. APR is typically higher than the interest rate because it includes these additional costs, making it useful for comparing loan offers from different lenders.
The mortgage interest rate is the cost of borrowing money, expressed as a percentage of the loan amount charged annually. Rates are influenced by economic factors, your credit score, down payment, loan type, and term. The rate directly affects your monthly payment: on a $300,000 loan, each 1% rate increase adds roughly $170/month to your payment.
A down payment is the upfront cash you pay toward a home purchase, expressed as a percentage of the purchase price. Requirements vary by loan type: conventional allows 3-5% for many first-time buyers, while jumbo loans often require 10-20%. Putting 20% down avoids private mortgage insurance (PMI) on conventional loans.
Home equity is the difference between your home's market value and what you owe on your mortgage. For example, if your home is worth $400,000 and you owe $300,000, you have $100,000 (25%) in equity. Equity builds through mortgage payments and home appreciation. You can access equity through cash-out refinancing, HELOCs, or home equity loans.
Loan-to-value ratio (LTV) is your loan amount divided by the home's appraised value or purchase price (whichever is lower), expressed as a percentage. For example, borrowing $240,000 on a $300,000 home = 80% LTV. Lower LTV means more equity and often better rates. LTV above 80% on conventional loans requires PMI.
Debt-to-income ratio (DTI) compares your monthly debt payments to your gross monthly income. Lenders use two DTI calculations: front-end (housing costs only) and back-end (all debts including housing). Most lenders prefer back-end DTI under 43%, though exceptions can be made with strong compensating factors. Lower DTI improves approval odds and may qualify you for better rates.
Amortization is the process of paying off a mortgage through regular payments over time. Each payment includes principal (reducing your balance) and interest. Early in the loan, most of your payment goes to interest; over time, more goes to principal. An amortization schedule shows how each payment is split and your remaining balance throughout the loan term.
Closing costs are fees and expenses paid when finalizing a mortgage, typically ranging from 2-5% of the loan amount. They include origination and processing fees, third-party fees (appraisal, title insurance, attorney), prepaid items (property taxes, insurance), and government fees (recording). Some costs are negotiable or can be rolled into the loan.
Private mortgage insurance (PMI) protects the lender if you default on a conventional loan with less than 20% down payment. PMI typically costs 0.5-1.5% of the loan amount annually, added to your monthly payment. PMI can be removed once you reach 20% equity (and must be automatically cancelled at 22%).
Discount points are upfront fees paid to the lender at closing to reduce your interest rate. One point equals 1% of the loan amount and typically lowers the rate by 0.25%. For example, on a $300,000 loan, one point costs $3,000. Points make sense if you'll keep the loan long enough for monthly savings to exceed the upfront cost (break-even calculation).
Escrow has two meanings in mortgages: (1) During purchase, an escrow account holds earnest money and funds until closing. (2) After closing, an escrow account is maintained by your lender to pay property taxes and homeowners insurance. Your monthly payment includes principal, interest, plus escrow contributions. Lenders analyze escrow annually and adjust payments accordingly.
Mortgage pre-approval is a conditional determination issued through a creditor or loan program based on verified income, assets, credit, and debt. Unlike pre-qualification (a rough estimate), pre-approval usually involves a credit check and document review. A pre-approval letter can strengthen your offer when buying by showing sellers that financing has been reviewed.
Refinancing replaces your existing mortgage with a new loan, typically to get a lower interest rate, change loan terms, or access equity (cash-out refinance). Rate-and-term refinancing changes the rate or term without taking cash. Refinancing has closing costs (2-5% of loan), so you should calculate break-even time to ensure savings exceed costs.
A credit score is a three-digit number (300-850) that represents your creditworthiness based on your credit history. For mortgages, FICO scores are typically used. Higher scores generally qualify for more favorable pricing. Minimum requirements vary by loan type: conventional typically requires 620+, and jumbo loans often need 700+.
Now that you understand the terminology, let us help you find the right mortgage for your needs.
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