1. What is a Secured Loan?
Secure loans use assets as collateral as a condition of borrowing. Secured loans can be business or personal loans and the lender places a lien on the assets put up for collateral until the loan is repaid in full. As a condition of the lending if the borrower fails to meet the monthly loan payments the loan will default. As part of the secured loan terms when the loan defaults the lender can claim the borrowers’ assets used for collateral. Some examples of secured loans are mortgages and home equity loans.
2. What is a Mortgage?
A mortgage is a type of loan available from banking and other financial institutions that helps a borrower purchase a new home or refinance the home the borrower currently has. This loan type is a secure loan in the case where the asset put up as collateral for the loan type is the home itself. When the borrower fails to repay the monthly mortgage payments resulting in the mortgage defaulting, the Lender will reclaim the house and sell it to recover any losses. The borrower needs to meet the mortgage monthly payments and prevent the loan from defaulting. Once the mortgage has been completely paid off there is no longer a lien placed on the house/ asset by the lender. Mortgages consist of down payments, monthly mortgage payments and fees.
3. What Is A Down Payment?
Most mortgages require the borrower to pay a percentage of the mortgage upfront that depends on the type of loan selected. A down payment is your initial contribution and investment in the purchase of your new home. Depending on the type of loan the size of the down payment will vary. A good rule of thumb to go by when understanding down payments is that the larger the initial contribution amount the smaller the monthly mortgage payments will be because the down payment is put towards the total cost of the home.
When it comes to borrowing the higher the down payment that you can provide creates a higher opportunity to receive lower interest rates on your mortgage. This is because there is a lower risk to the lender when a larger portion of the home is provided in the down payment by the borrower. Simply put the smaller the down payment the longer it takes to pay off the mortgage, the higher the monthly payments are and the more risk the lender sees of the borrower resulting in the more likelihood of receiving higher interest rates when applying for a mortgage.
4. How Does Amortization Work?
A mortgage is a type of amortization loan where the total price of the home is paid in monthly installments throughout the life of the mortgage loan. Amortization is the process of paying instalment payments on a loan. The amortization of a mortgage consists of monthly payments broken down into principal and interest payments. During the early years of the mortgage loan, the bulk of the monthly mortgage payment goes towards the interest payments rather than towards the principal balance of the mortgage loan. Throughout the mortgage loan, the amount of the monthly mortgage payment that goes towards the principal balance of the mortgage gradually increases each month until the full balance of the mortgage is paid off when the mortgage term matures. You can ask your mortgage lender for a breakdown of the monthly mortgage payments that shows exactly how much of the monthly mortgage payments go towards the interest and the principal balance over the entire mortgage term; this is called the amortization schedule.
5. What Is Escrow And How Does It Work?
When purchasing a home the lender will require an escrow account to be opened. The Escrow account is for the borrower to put the required monthly payments for property taxes and mortgage insurance premiums into the escrow account. Even though the property taxes and mortgage insurance premiums are paid annually the monthly payments ensure the lender that the borrower can afford the payments and the property taxes and mortgage insurance premiums will be paid on time every year.
These monthly payments help prevent a foreclosure from happening were to recover the costs of the loan the lender is forced to put a lien up against the property. Escrow services like any other service used when purchasing a home have fees attached to them. The fees for the escrow service usually run 1-2% of the home loan which generally speaking can be around $2,000-4000 and in some cases more but these fees will be included with the rest of the closing costs of the mortgage.
Escrow agents work as a neutral third party that monitors and assists in the final steps of the home purchase making sure that the conditions of the sale are fully meant especially in regards to the “earnest money” portion. When purchasing a home to show the seller that you are serious about the offer to have the home taken off the market you may be required to put an “earnest money” deposit into the escrow account. The earnest money amount will be anywhere from 1-32% of the final price of the home and will be used towards the down deposit of the home once everything is finalized. It is important to note that if the buyer and seller do not reach an agreement for the purchase of the home the earnest money may be forfeited.
6. What Is Equity And How Do You Calculate It?
Home equity is a very valuable asset to borrowers as it represents the portion of the property in which they truly own over the lender which shares ownership in the property until the mortgage is fully paid off. Equity is calculated based on the market value of your home minus the remaining balance on the mortgage. You can get an idea of how much equity you have built up by acquiring a property assessment to find out the true market value of your home.
7. What is APR?
The annual percentage rate (APR) is the cost of not only interest payments but includes other fees associated with getting a mortgage including originating fees, broker fees, points and other possible fees attached to the overall cost of the mortgage. Most fees included in APR are; mortgage broker fees, transaction fees, mortgage insurance, application and processing fees, legal fees, originating fees, mortgage underwriter fees, discount points, and certain closing costs. APR percentages will give you a clearer vision of how much exactly the total cost of the mortgage loan will cost you since it is not just interest rates but rather includes the additional fees that are why APR rates will be higher than interest rates on the same mortgage loan amounts. When purchasing a mortgage it is good to compare APR with different lenders to see how much you can save.
8. Principle Balance
When taking out a mortgage the principal balance will be the initial cost of the mortgage loan excluding all the additional fees attached when getting a mortgage such as; interest, closing costs and any fees associated with purchasing a home. For example the home you would like to purchase costs $350,00 and you have saved 5% of the mortgage to put towards the purchase of the home as the down payment. The principal balance would equal the price of the home $350,000 minus the 5% down payment that you put towards the purchase of $17,500. The principal balance that you borrow from the lender for the mortgage will be equal to $332,500.00. The principal balance is the amount you need to borrow from the lender to pay for your home in the form of a mortgage.
When you borrow money from a bank or another Lending institution you will have to pay a fee in the form of interest payments in exchange for receiving the loan from the lender. The interest payments charged for borrowing the mortgage loan will be attached to your monthly mortgage repayments. Interest fees are measured in percentage rates like APR however, interest rates do not include the additional fees that are included in a mortgage such as originating fees, closing costs and other fees associated with a mortgage. This is why interest rates appear to be lower than APR rates. It is important to find out the total costs of all fees associated with the mortgage to see if you are saving money with the lower interest rates versus getting a mortgage with APR instead. If you do decide to go with the interest rates instead of APR a helpful tip to keep in mind is the longer the mortgage term you choose the more interest you will pay at the end versus the interest on a shorter mortgage term.
10. Discount Points
Discount points also known as mortgage points are required by law to directly lower the interest rates on the mortgage loan. The discount points are included in the closing costs of the loan and represent 1% of the total loan amount for each point. For example say you are purchasing a mortgage loan of $300,000 one discount point would equal out to be $3,000, two discount points on that same loan amount would be $6,000 and 3 discount points would be $9,000 and so on. Discount points do not have to be paid as a whole number you can pay 1.25,1.5,1.75 etc of discount points. Keep in mind that if you do not plan to stay in your new home for long or plan to refinance discount points will not necessarily save you money in the long run. To find out if discount points will optimize your overall mortgage loan you can do these simple calculations to find the break-even point; discount point cost divided by the monthly loan payment savings to equal out the total number of months required to stay into the mortgage loan for you to benefit from the savings of the discount points.
The percentage that the interest rates will be lowered by the number of discount points you pay on your mortgage loan will vary between lenders and depend on the type of the mortgage loan, the lender chosen, and the state of the mortgage market. It is important when shopping around between lenders on the same mortgage loan amount to look into not only the mortgage interest rates but the exact amount the discount points will reduce the interest rates between each lender. By taking into account those key factors that affect discount points between lenders you will optimize your overall savings on your mortgage amount.
11. Originating Fees
To set up a loan and sort through all the necessary documents to process the loan application the lender will charge the borrower fees known as originating fees. The Originating fees will be part of the closing costs of the mortgage loan and are found in the loan estimate under Section A: Origination Charges. The originating fees will cost between 0.5-1.0% of the total cost of the mortgage so for example the total mortgage costs $300,000, the originating fees will be between $1,500-$3,000.
The originating fees are usually broken down into a few categories under originating charges and can include discount points, originating fees, appraisal review fees, underwriting fees, administration fees, document preparation fees and other related fees. Some of these fees can be negotiated especially when you have a higher credit level, stable income and are applying for a large mortgage loan. If you find that you are having a harder time negotiating you can always try bargaining with the seller to cover the originating fees which may be easier to convince the seller if they need the home to be sold very quickly.
12. What is Title Insurance?
When purchasing a home and transferring the ownership from seller to buyer there may be the occasion where a dispute arises about the title ( legal property ownership) and this is where title insurance comes into play. Title insurance protects the lender and borrower from any financial losses occurring from a title dispute after the point of sale of the home has been finalized and from any liens on the property from unpaid property taxes. Lenders will require the borrower to purchase lenders’ title insurance when purchasing a mortgage. Lenders’ title insurance will run between 0.5-1.0% of the total mortgage loan and will be included in the closing costs of the mortgage loan. It is important to note that lenders’ title insurance only protects the lender from incurring financial losses in the event of a title dispute. To ensure the borrower is protected from the possible financial losses as a result of a title dispute the borrower will have to additionally purchase the owner’s title insurance as well.
The Bottom Line
With all the complicated mortgage jargon, choosing a home loan can be confusing. We hope this glossary has helped you better understand some of these terms and learn how they apply to mortgages. Now you will have an even easier time deciding on a plan that suits your financial situation when it is time to choose an interest rate for your new home loan.