Mortgage Terminology You Need to Know

Reviewed: February 21, 2014
By FinanceWeb

Although home lenders can be difficult to understand at times, they are not speaking a foreign language. By understanding these common mortgage terms, borrowers can feel confident when buying or refinancing their homes.

Mortgage

A residential mortgage is a contract that lets individuals pledge their homes as collateral for a bank loan. Mortgage lenders offer many types, including fixed-rate home loans with stable interest rates and adjustable rate mortgages, or ARMs, with variable interest terms.

Prequalification

When a borrower is prequalified for a home loan, she receives a ballpark figure of how much she can borrow and under what terms. The bank looks at income, expenses, assets and debts. Prequalifying for a mortgage involves an estimate online or over the phone; it is not a promise for funding.

Preapproval

To be preapproved for a mortgage, a borrower must submit an application, undergo a credit check and answer detailed financial questions. The lender then issues a conditional guarantee for a certain size of home loan. Borrowers may be able to lock in a specific interest rate at this time. Sellers often take homebuyers with preapproval letters more seriously because they know that financing is secure.

Loan-to-value ratio, LTV

The loan-to-value ratio compares how much a property is worth to how much someone must borrow in order to buy it. For example, a $150,000 loan on a $200,000 property gives an LTV ratio of 75 percent (150000/200000=0.75). Many banks consider LTV ratios above 80 percent to be high-risk, so they require private mortgage insurance as a condition of pre-approval.

Private mortgage insurance, PMI

Homebuyers who put down less than 20 percent of the purchase price must often pay for private mortgage insurance. For each $100,000 borrowed, PMI adds between $30 and $120 to the monthly house payment. Some lenders will drop the PMI charge once a loan’s LTV reaches 80 percent. New FHA loans mandate an upfront PMI fee plus a monthly charge for the life of the mortgage.

Debt-to-income ratio, DTI

This calculation lets mortgage lenders see how much a potential homeowner will be spending on housing and other expenses. A debt-to-income ratio of 28/43 means that a person can spend up to 28 percent of his gross monthly income on PITI and up to 43 percent on both PITI and recurring debt. FHA loans are popular because they stretch these limits to 31/43 for first-time homebuyers.

PITI

A person’s total housing expense is often called PITI, which refers to principal, interest, taxes and insurance.

Discount points

Many mortgage lenders let borrowers prepay interest by buying points. Each point decreases the interest rate by 0.25 percent, so buying three points would drop a 6 percent interest rate down to 5.25 percent.

Reputable lenders are willing to talk about these terms and other mortgage definitions. Home loan customers should never be afraid to ask questions about their finances.