Buying a new home is exciting, but financing it can be confusing, especially for first-time buyers. Mortgage lenders often use unfamiliar terms and abbreviations that make the process seem complicated. Understanding these terms can help you compare loan options, ask better questions, and know what to expect before signing on the dotted line. 

Mortgage Basics 

Mortgage: A loan used to buy a home, with the property serving as security for the loan. Most mortgages are repaid through monthly payments over 15 or 30 years. 

Principal: The amount you borrow, excluding interest and other loan costs. As you pay down the principal, you reduce the amount you owe. 

Interest Rate: The percentage a lender charges to lend you money. Even a small difference in interest rates can significantly affect your monthly payment and total borrowing costs. 

Annual Percentage Rate (APR): A yearly measure of borrowing costs that includes your interest rate and certain loan fees. APR helps you compare mortgage offers from different lenders. 

Fixed-Rate Mortgage: A loan with an interest rate that stays the same throughout its term. Your principal and interest payment remains unchanged, although property taxes and insurance may increase. 

Adjustable-Rate Mortgage (ARM): A mortgage with an interest rate that may change after an initial fixed-rate period. Your monthly payment could increase or decrease depending on the loan terms and market rates. 

Qualifying for a Mortgage 

Prequalification: An early estimate of how much you might be able to borrow, generally based on financial information you provide to a lender. 

Preapproval: A more detailed review of your income, credit, savings, and debts. Preapproval helps establish your potential borrowing limit and can strengthen your position as a buyer, but doesn’t guarantee final loan approval. 

Credit Report: A record of your credit history, including loans, credit cards, balances, and payment history. You can obtain free weekly reports from Equifax, Experian, and TransUnion at AnnualCreditReport.com. Checking your own report does not lower your credit score. 

Credit Score: A three-digit number, generally ranging from 300 to 850, that helps lenders evaluate how likely you are to repay borrowed money. FICO and VantageScore are two common scoring systems. You can obtain your score through credit bureaus, banks, or credit card companies, sometimes for free. 

FICO Score: A type of credit score widely used by mortgage lenders to evaluate borrowers and determine loan eligibility and interest rates. A FICO Score is a credit score, but not all credit scores are FICO Scores. Different scoring models may produce different results. 

Debt-to-Income Ratio (DTI): The percentage of your monthly income before taxes used to pay debts, including your proposed mortgage payment. Lenders use this ratio to help determine whether you can afford a home loan. 

Loan-to-Value Ratio (LTV): The percentage of a home’s value that you’re borrowing. For example, borrowing $180,000 on a home valued at $200,000 results in a 90% LTV. A lower LTV generally means less risk for the lender. 

Understanding Costs and Payments

Down Payment: Money paid upfront toward your home’s purchase price. While 20% is often mentioned, some conventional loans allow down payments as low as 3%, and certain programs offer no-down-payment options to eligible buyers. 

Private Mortgage Insurance (PMI): Insurance that protects the lender if you fail to repay your mortgage. PMI is generally required on conventional loans when your down payment is less than 20%. It adds to your monthly housing costs. 

Escrow Account: An account your mortgage servicer uses to collect money through your monthly payments for property taxes and homeowner insurance. The funds are used to pay those bills when due. 

Closing Costs: Expenses paid when completing a home purchase, including lender fees, appraisal charges, title insurance, and other services. These costs are generally separate from your down payment and should be included in your budget. 

Discount Points: Fees paid upfront to reduce your mortgage interest rate. One point equals 1% of your loan amount. Whether paying points saves money depends partly on how long you keep the mortgage. 

Mortgage Rate Buydown: An arrangement that lowers your mortgage interest rate temporarily or permanently. Some builders offer buydowns as incentives to reduce buyers’ monthly payments. With a temporary buydown, understand how much your payment will increase when the reduced-rate period ends. 

Loan Estimate: A document showing estimated loan terms, monthly payments, and closing costs. For most mortgages, lenders must provide it within three business days after receiving the six key pieces of information that constitute a mortgage application. 

Closing Disclosure: A document showing your final mortgage terms, monthly payment, and closing expenses. For most mortgages, you must receive it at least three business days before closing, giving you time to review the figures and ask questions.