5 Mortgage Terms You Need to Understand Before Applying for a Home Loan

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These are some key terms to familiarize yourself with before getting a mortgage.

Key points

  • In the course of applying for a mortgage, you may come across terms you're unfamiliar with.
  • Understanding what these common terms mean could make the process of getting a home loan less stressful.

If you're gearing up to buy a home, you'll probably need a mortgage to finance that purchase. But if you're new to the process, you may find yourself overwhelmed once you begin putting together your application.

Not only do you have to provide a fair amount of financial data for mortgage lenders to review, but you may also come across a number of terms you don't quite understand. With that in mind, here are a few commonly used mortgage terms it'll help you to be familiar with.

1. Fixed-rate mortgage

With a fixed-rate mortgage, the interest rate you pay on your home loan will stay the same until your mortgage is paid off. That means you'll enjoy the benefit of predictable monthly payments. As an example, if you sign a 30-year fixed loan at 3.2%, that 3.2% rate will apply to all of your payments under that loan.

2. Adjustable-rate mortgage

An adjustable-rate mortgage (ARM) is a home loan whose interest rate can change over time. There are different types of adjustable-rate loans. A 5/1 ARM, for example, gives you the same interest rate for five years, after which that rate can adjust once a year. A 7/1 ARM gives you the same interest rate for seven years before potentially adjusting once annually.

The downside of an ARM is your mortgage payments could rise over time if your rate increases. But your rate could also adjust downward, making your payments cheaper.

3. Principal and interest

Your monthly mortgage payment consists of a principal portion and an interest portion. Your principal is the balance of your loan you're chipping away at. Interest refers to the interest you're paying on that principal, and it will stay the same if you get a fixed loan and potentially change if you have an adjustable-rate mortgage. To be clear, though, when we say "stay the same," we're talking about your interest rate.

When you first start paying off your mortgage, a large chunk of your monthly payments will go toward interest on your loan. Over time, that will shift, and you'll start paying more toward your principal and less toward interest.

4. Private mortgage insurance (PMI)

PMI, or private mortgage insurance, is a premium you pay (usually on a monthly basis) on top of your regular mortgage payment of principal and interest. PMI applies when you don't make a 20% down payment on your home at closing. The purpose of it is to protect your lender in the event you don't keep up with your monthly payments.

5. Closing costs

Closing costs are the various fees you'll pay to finalize your mortgage. They generally amount to 2% to 5% of your loan amount and vary by lender.

Closing costs are comprised of different fees, like application fees and appraisal fees. They can sometimes be negotiable, but not always. You don't automatically have to pay your closing costs at the time of your signing. If you'd rather not pay them up front, you can roll them into your mortgage and pay them off over time.

Getting a mortgage can be daunting, especially when terms keep getting tossed around that you don't understand. Knowing these terms could help you approach the application process with a lot more confidence -- and less stress.

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