When applying for a mortgage, you’ll likely come across a lot of unfamiliar terminology that can be confusing, like FHA, DTI, PMI and LTV. Find out what these and other key mortgage terms mean.
Whether you’re going through your first mortgage experience, or you’ve been through the process a time or two, you may see mortgage terms that are unfamiliar. Do you know what points have to do with buying a house? You have an APR on your credit card, but what does it mean with your mortgage?
Let’s take a look at key mortgage terms, what they mean, their significance and when a homebuyer will see these terms.
Escrow
Definition: An escrow account is where funds, such as taxes and insurance, are held by a third party to ensure that conditions in a real estate transaction are met.
Implications: It ensures that property taxes and insurance premiums are paid on time. Escrow can affect closing costs and monthly payments.
When you’ll see it: Throughout the mortgage process, particularly at closing and in monthly statements.
Earnest Money Deposit (EMD)
Definition: An EMD is a deposit that’s made by the buyer to show their serious intent to purchase a property. It is typically held in an escrow account (and even be casually referred to as an “escrow deposit”) until closing.
Implications: An EMD can affect closing costs, as this deposit is usually credited toward the buyer’s down payment or closing costs. If the deal falls through due to the buyer’s fault, the seller may keep the EMD.
When you’ll see it: Typically, during the house-hunting phase, when making an offer.
Taxes & Insurance (T&I)
Definition: These are payments collected by the lender for property taxes and homeowners insurance, often held in an escrow account.
Implications: T&I can increase the monthly mortgage payment, as the lender collects these amounts to pay the bills on behalf of the homeowner.
When you’ll see it: On the monthly mortgage statement and during closing as part of the escrow setup.
Principal, Interest, Taxes and Insurance (PITI)
Definition: PITI represents the total monthly mortgage payment, including the principal, interest, property taxes and homeowners insurance.
Implications: This gives the full picture of the borrower’s monthly payment obligations.
When you’ll see it: On monthly mortgage statements and during loan discussions with lenders.
Annual Percentage Rate (APR)
Definition: APR reflects the true annual cost of borrowing, including interest and any additional fees or costs.
Implications: A higher APR means a higher cost of borrowing. It’s important to know each loan offer’s APR when comparing different options.
When you’ll see it: During the loan application process and in loan estimates provided by lenders.
Debt to Income (DTI) ratio
Definition: The DTI ratio is the percentage of a borrower’s gross monthly income that goes toward paying debts.
Implications: A higher DTI can affect loan approval chances and loan terms. Lenders typically prefer a lower DTI.
When you’ll see it: During the loan prequalification and approval processes.
Loan to Value (LTV) ratio
Definition: LTV ratio is the ratio of the loan amount to the appraised value of the property.
Implications: A higher LTV can result in higher interest rates and the need for PMI. It also influences loan approval.
When you’ll see it: During the loan application process and property appraisal.
Private Mortgage Insurance (PMI)
Definition: PMI is insurance required by lenders if the down payment is less than 20% of the home’s purchase price. PMI protects the lender if you stop making payments on your loan.
Implications: It increases the monthly mortgage payment until the borrower reaches 20% equity, at which time, the borrower can request cancellation.
When you’ll see it: During loan approval and on monthly mortgage statements.
Federal Housing Administration (FHA)
Definition: FHA is a government agency that provides mortgage insurance on loans made by FHA-approved lenders.
Implications: FHA loans often require lower down payments and have more lenient credit requirements, but they include mortgage insurance premiums (MIP).
When you’ll see it: When applying for an FHA loan and on monthly statements.
Prequalification letter
Definition: A preliminary assessment by a lender of how much you might be eligible to borrow based on self-reported financial information.
Implications: It gives a rough idea of your borrowing power, but is not a guarantee of a loan.
When you’ll see it: Early in the house-hunting process.
Preapproval letter
Definition: A more detailed evaluation where the lender verifies your financial information and conditionally approves you for a specific loan amount.
Implications: Stronger than prequalification, it indicates to sellers that you are a serious buyer and have your financing lined up. It may also provide an advantage over another potential buyer if the seller is considering two similar offers.
When you’ll see it: After submitting financial documents and undergoing credit checks.
Points (or discount points)
Definition: Points are upfront fees that are paid to the lender at closing in exchange for a reduced interest rate on the mortgage. One point typically equals 1% of the loan amount.
Implications: Paying points can lower your monthly mortgage payment and reduce the total interest paid over the life of the loan. Determine if paying points is beneficial by comparing the upfront cost against the long-term savings from a lower interest rate.
When you’ll see it: In discussions with the lender prior to closing, and at closing.
Adjustable Rate Mortgage (ARM)
Definition: A type of home loan where the interest rate can change periodically based on the performance of a specific index. Typically, an ARM starts with a fixed interest rate for an initial period (such as 3, 5, 7, or 10 years), after which the rate adjusts annually according to the index it is tied to.
Implications: ARMs can offer lower initial interest rates compared to fixed-rate mortgages, making them attractive for borrowers who plan to sell or refinance before the adjustable period begins. However, because the interest rate can increase after the initial fixed period, there’s a risk of higher monthly payments later on.
When you’ll see it: Early in the mortgage application process, especially when discussing loan options with your lender. They are usually presented as an option when you’re deciding between fixed-rate and adjustable-rate mortgages.
Jumbo loan
Definition: A type of mortgage that exceeds the conforming loan limits set by the Federal Housing Finance Agency (FHFA). These limits vary by region but generally, any mortgage larger than the conforming limit (currently $766,550 for most areas as of 2024) is considered a jumbo loan.
Implications: Jumbo loans come with different underwriting standards compared to conforming loans. Since they are not backed by government-sponsored entities like Fannie Mae or Freddie Mac, they often require higher credit scores, larger down payments and lower debt-to-income (DTI) ratios. Additionally, interest rates on jumbo loans can be higher, reflecting the greater risk to the lender.
When you’ll see it: You’ll encounter jumbo loans during the mortgage application process if you’re purchasing a high-value property that requires borrowing more than the conforming loan limit. Your lender will inform you if your loan amount qualifies as a jumbo loan.
These key mortgage terms are valuable in understanding the full scope of mortgage payments, closing costs and the home buying process. Use our guide to arm yourself with the knowledge you need to successfully navigate this process and your mortgage payments for years to come.
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