Common Real Estate Finance Terms and Definitions
You want to buy a house. It is a big step and a large expense. It is probably the most expensive item that you will ever buy. Most of us buy a house with the intention of staying in that house for a really long time. Others are looking for a starter home with the intention of buying a bigger home at some point in the not so distant future. Regardless of your intention when buying a house, there is a lot of information and terminology around house buying. It can be overwhelming. Since it is such a large purchase, you want to make sure you are making the right decisions. You should become familiar with real estate finance terms before you begin looking for a house.
One of the most important real estate finance terms that you should learn before you consider buying a house, is a mortgage. In its simplest definition, a mortgage is a loan for property, such as a home. You pay back the money over time by making regular monthly payments. The lender adds interest to the amount of money that you borrow.
A mortgage is different than other loans because you are using your house or property as collateral. That means that if you stop paying on your mortgage, the lender has the right to take your house. You do not own the house completely until you pay the mortgage in full. With each payment you make, you own a little more of the house, which is called equity. One of the great things about a mortgage is it allows you to purchase a house, which many of us would not be able to afford if we had to pay for it all at once. It does, however, account for a large amount of debt at one time.
Different Types Of Mortgages
That was a really simple explanation of a mortgage. There are many different types of mortgages and when considering important real estate finance terms, mortgage types are at the top of the list.
Conventional Mortgages
This is the most common type of mortgage you are going to find. The rate is fixed, which means the agreed-upon interest rate remains the same for the life of your mortgage. The mortgages usually come in terms such as 15-year, 20-year, 30-year, and even 40-year loans. The most common ones have 15 or 30-year terms. A lender wants you to have 20 percent of the cost of the house to put down on the house.
In numbers, this means, if you want to purchase a house that is $250,000, your down payment must be $50,000. If you cannot put down that amount, the lender requires you to have private mortgage insurance (PMI). I will explain more about PMI further down in this article. Lenders look for you to have a higher credit score to qualify for this type of mortgage. The good news is if you have a high credit score, you may be approved with only 3 percent down.
Adjustable Rate Mortgages (ARM)
These mortgages give you a lower interest rate upfront, but will increase over time. The rate is adjustable, as suggested by the name, and as a result, your monthly payment will most likely change at some point. The most common ARM mortgage is what is called a 5/1 mortgage. This means that your interest rate stays the same for 5 years, but then can change for the rest of the time you have this mortgage. The interest rate is based on the economy. Many like this type of mortgage because it gives you a lower monthly payment for the first 5 years. The key to remember is your mortgage can jump up significantly after that. Many decide to refinance with a fixed rate mortgage before the 5 years expires. This is a good idea as long as the value of your house does not decrease over the next 5 years.
Balloon Mortgages
These are an interesting type of mortgage and they really are not that common. With this mortgage, you pay a lower monthly amount, often times just enough to cover the interest rate. Then at a specific time, you pay the entire amount of the loan that is due. It is usually a large amount of money. Think of a balloon and how it is small at the bottom and get larger as you move to the top. The same is true for this mortgage. This may be a good idea if you are selling another property but the sale is not final by the time you need this mortgage. If you know you will have the money to make the payment, this mortgage might work for you.
Interest Only Mortgages
This are similar to balloon mortgages except the monthly amount you pay increases more gradually. In this case, the early payments you make are interest only and then at a specified time, you begin to pay a larger amount per month, which includes the principal of the loan.
And If you are interested in today’s mortgage rates, you can take a look at the table below:
What Is Interest And PMI?
We cannot possibly talk about real estate terms without mentioning interest and PMI. These are two vastly different topics, but equally important ones. Interest is what the lender gives you for them allowing you to borrow money. Your interest rate is based on your credit score. The higher your credit score is then the more likely the lower your interest rate is going to be.
Also, the more money you put as a down payment for your house may also help to decrease the amount of interest you pay. When you put a larger amount down, the bank sees you as less of a risk because you already potentially have more equity in your house. If you have bad credit, it can add up to 2 percent interest on to your loan. Slightly better than bad credit may get you a 1 percent increase in the interest rate you are given for your mortgage.
Learn Everything about Real Estate with the Accury store.
I can highlight the difference for you with some numbers
Good credit
If you have great credit, you may see a 5 percent interest rate.
If you want to purchase a $300,000, that makes your total interest equal $15,000.
That brings your house purchase to $315,000 and your mortgage payment to $1312.50.
Poor credit
Now, let's say you have poor credit and it adds 3 percent to your interest rate bringing it up to 8 percent.
That means you are paying $24,000 in interest which brings your total cost to $324,000 and your monthly mortgage payment to $1350.
I want to talk for a moment about Private Mortgage Insurance (PMI). I mentioned earlier in this article that lenders prefer that you have 20 percent down for your mortgage. This gives them a feeling that it is less risky to lend you money because you are already starting with 20 percent equity in the house. That means if they foreclose on you and take your house from you, they do not have to make as much money on the sale to get back the money they put out for your mortgage.
When you do not have 20 percent down, they want you to have mortgage insurance, which is paid by an outside insurance company basically covering you for the rest of the 20 percent of the house that you do not have to put down. This insurance costs you money, of course. It adds to your regular monthly mortgage payment. It can add several hundred dollars to the cost of your monthly mortgage.
What Do I Need To Know About Points?
Points are another one of the fun real estate terms that you want to understand. You do not have to pay for points. This is completely optional for you. It is a way to decrease how much interest you have to pay. If you find yourself facing a high interest rate, you may want to consider paying for point. You must pay for them upfront at the closing on your house. So you must have the cash to pay for points. Consider that before you agree to them.
One point can decrease your interest rate by .25 percent.
That means if you are facing an 8 percent interest rate, you can decrease it to 7.75 percent. You would have to pay for 4 points to bring your interest down by an entire percent. Before you get too excited, you should understand the cost of a point.
A point is going to cost you 1 percent of the amount of your loan. That equals to $1,000 for every $100,000. In the example above, your loan is $300,000, that means 1 point will cost you $3,000. You will pay $3,000 up front to drop your interest rate by .25 percent. It may be worth it to you, but it may not. It is something you should carefully consider.
What Is A Mortgage Broker?
One of the common real estate finance terms you may hear is a mortgage broker. You do not need a mortgage broker to buy a house or get a mortgage. You may want to consider one, but no means do you have to have one. A mortgage broker may make the process easier for you. If you are looking for something that makes the mortgage and house buying process easier for you, then a broker may be something you want to consider. A mortgage broker does get paid to provide services to you.
This person is a middleman for you. Their role is to find the best mortgage rates for you and your credit score. A broker works hard to find the right fit for you. They work with banks and applies for many different mortgages that they feel for which you may qualify. They gather all the documents you need, including a credit report, verify income and employment. Once you select a mortgage for you, the mortgage broker works with the underwriter for the lender, real estate agent, and the closing company to make this transaction as smooth as possible for you.
What Is A Reverse Mortgage?
Another one of the real estate terms for consideration is a reverse mortgage. When there is a reverse mortgage purchase, it is a loan against the value of your home. To qualify, you must be 62 years of age or older and have a large amount of equity in your house. When it comes to reverse mortgages, you can get one lump sum, a regular payment each month, or a line of credit. You do not have to make loan payments. You pay back the loan upon selling the house, moving out of it, or death. These mortgages are federally regulated and the lender cannot loan more money than the value of the house. If the loan amount exceeds the value of the house, you are not responsible for the difference. This can happen when the value of the house drops or if you live longer than expected.
Appraisals And Inspections, Oh My
There are two real estate terms that you do not want to overlook. Often, potential home buyers consider waiving an appraisal or home inspection. I recommend that you do not even consider it. Even if they add a little more time to the home buying process, it is worth it. Even though you may need to pay for them, they are still worth it.
An appraisal is a written document that provides proof of the value of the home you want to buy or sell. It is based on an analysis of your home and the comparison of the sale of houses close to the house.
A home inspection is done by a professional that is qualified to evaluate the structure of the house and property. This person also looks at the condition of the mechanical equipment in the house. You should not purchase a house without a positive home inspection.
What In The World Is Escrow?
One of the real estate terms that tends to be confusing for people is Escrow. An escrow account is created upon the purchase of your home. Any amount you pay each month includes an extra amount above your principal and interest. The extra money is held in your escrow account to pay for items such as property taxes and homeowner's insurance when they come due. The lender pays them with your money instead of you paying them yourself.
What Is Closing And Closing Costs?
Of all the real estate terms, these may be the best ones because they indicate the end of the process. When you get to closing that means you have gotten almost all the way through the purchase of your home and you are a few signatures away from owning your house.
At closing, you sign all the documents for the mortgage and to complete the purchase of your home. You meet with an attorney to finalize this process. The attorney takes the money from the lender and gives the seller of the house the money for the house.
These costs include all administrative costs. It may also include appraisal and credit report fees, attorney fees, recording fees, survey fees, termite inspections and title insurance. All of the documents are kept on record at the courthouse.
A Few More Terms...
This is an item in the contract that states you repay all the money you still owe the lender if specific criteria are not met.
This is a listing of every one of your mortgage payments and the date it is due for the life of your mortgage.
This is a way to get your interest rate lowered by the seller making a payment to the lender which decreases the amount you borrow.
When you refinance your house for more than it is worth and you take the difference in cash.
This is a part of the contract that must be fulfilled before the sale of the house, or the contract is voided.
This gives the government the ability to use private property for public reasons.
This is when you submit an application to a lender. There is usually a fee with this process.
Short for principal, interest, taxes, and insurance and is the sum of these charges.
This is when the owner sells their house for less than what they own on their mortgage.
Conclusion
This article gives you a large number of real estate terms that are helpful to you during the purchase, and possibly sale of a house. It is important that before you pursue buying a house, you understand what you are getting yourself into. You should have a working knowledge of all of these common terms before you begin to look for a house.