Mortgage Terms Every First-Time Home Buyer Should Know

By: Peter Warden Reviewed By: Paul Centopani
August 7, 2023 - 11 min read

Conquer the jargon, conquer home buying!

From doctors to lawyers to IT specialists: Every profession uses jargon. The mortgage industry is no different and understanding those terms can greatly impact the smoothness of purchasing property.

A 35% share of consumers didn’t know what a down payment was, according to Clever Real Estate. That share skews higher with younger demographics, as 43% of millennials and 56% of Gen Zers answered incorrectly, compared to 15% of Baby Boomers.

So, we’re pulling together some of the most common jargon associated with mortgage loans and explaining each in plain English.

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Be ahead of the game by understanding mortgage terms

Knowledge is power. And that applies as much to mortgage applicants as it does to any other sector where consumers deal with professionals.

So, don’t get lost in a blizzard of jargon. Learning the important mortgage buzzwords may well earn you respect and consideration from your lender and everyone else involved in your transaction.

Top 20 mortgage terms you need to know 

Tens of millions of Americans have mortgages. So, we’re dealing with a common piece of personal finances.

Of course, many of those borrowers got their mortgages without knowing much about what they were doing and let professionals guide them. And that’s fine, provided you’re in good hands.

But the process is much safer and less scary if you know what’s going on. And your first step toward that is understanding the following key mortgage terms. Every section will define each term, with a link provided for further information.

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1. Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage (ARM) is a loan product that starts with a fixed interest rate for a set number of years. After that period, the rate adjusts to meet the current market, usually on an annual basis.

Make sure your ARM comes with caps that limit how much your rate can rise each year and over its entire “term” (length) once your initial fixed rate expires. These can provide valuable protections if general interest rates soar. However, your rate will still rise in that case and you need to be sure you can afford your monthly payments if the worst occurs. (See fixed-rate mortgage, below.)

2. Amortization

Amortization concerns how each of your monthly payments is broken down between interest and “principal” (reducing the amount you borrowed). Just about all mainstream mortgages nowadays are “fully amortized,” which means you’ll owe nothing when you make your last scheduled payment.

Amortization is the process by which, month by month, the share of your payments going on interest gradually reduces and the share going on reducing your principal borrowing increases.

When you make your first payment, you owe a lot of money: your entire mortgage. And the interest on that is also a lot of money. So, the vast bulk of your first payment goes on interest.

When you make your last payment, perhaps 30 years later, you’ll owe very little. So, you pay a tiny bit of interest and the vast bulk of that last payment goes on reducing the principal you owe — to nothing.

3. Annual percentage rate (APR)

The APR can be a more useful guide to the cost of your mortgage than the raw mortgage rate. It tells you the total cost of borrowing that money each year if you were to spread closing costs and any mortgage insurance premiums over the term of the loan.

It’s common for mortgages with high closing costs to have lower mortgage interest rates. Conversely, you may be able to pay a higher mortgage rate but have lower closing costs.

If you compare APRs across different lenders, you can see which is offering the lowest total cost of borrowing.

4. Appraisal

Your lender has a legal duty to make sure the home you’re buying is worth more than (or as much as) you’re borrowing. So it sends in a professional appraiser to assess the market value of your home.

The appraiser produces a document providing their valuation. And that document (and the entire process on which it’s based) is called an appraisal. The value determined is called the appraised value.

5. Closing disclosure

A closing disclosure is a five-page form that provides the final details about your mortgage and comes as a part of the loan estimate (see below). It includes your personal information, the loan terms, your projected monthly payment amount, and how much you will pay in fees.

By law, lenders must give you the closing disclosure at least three business days before you close on your loan. The “three day rule” is meant to give you enough time to review your final terms and costs compared to your loan estimate, as well as time to ask your lender questions before heading to the closing table.

Closing disclosures don’t come with every type of mortgage application, including reverse mortgages, home equity lines of credit (HELOC) and manufactured housing loans.

6. Credit report

Your credit report is an electronic record, going back at least seven years, of your loan applications, open accounts (“trade lines”), on-time payments, late payments, defaults, bankruptcies, foreclosures and so on.

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You have at least three credit reports, one from each of the Big 3 credit bureaus. And they’re likely to be different because not all lenders report to all credit bureaus. By law, you’re entitled to a free copy of all your credit reports each year. And that’s something to take advantage of since credit report errors are staggeringly common. Here’s how to get yours.

7. Credit score

Two big companies in America, FICO and VantageScore, have developed sophisticated algorithms that regularly crawl over your credit reports.

They assign a numerical value to each item on your reports and, after some calculations, reduce your overall creditworthiness to a three-digit number of between 300 and 850 for the latest versions of their scoring systems. That’s your credit score and it’s entirely based on what’s in your credit reports.

But you have several — sometimes dozens of — credit scores. That’s because you’ll have one for each scoring technology and bureau, which makes six scores already. Then some lenders use older versions of those scoring systems. And FICO creates industry-specific versions, tuned to help lenders of auto loans, mortgages, and the like.

Once your loan offer is in place, avoid any new borrowing and the opening of new accounts that could affect your score. Lenders typically run your score again just before closing. And, if yours is worse than when you applied, you could face higher closing costs or a higher mortgage rate. If the change is serious enough, the whole offer could be pulled.

8. Debt-to-income ratio (DTI)

Mortgage lenders see your DTI as a key indicator of your ability to comfortably afford your new loan. It’s the proportion of your net (pretax) monthly income that immediately goes out to obligations.

Those include the homeownership costs on your home (payments on your mortgage, homeowners insurance and property taxes) plus payments on installment loans and minimum payments on credit and store cards. Alimony and child support count, too.

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Suppose the applicant(s) on a mortgage application earn $10,000 a month. If all those obligations add up to $4,000 a month, they’ll have a 40% DTI ($4,000/$10,000=40%). Most lenders look for DTI ratios below 43%.

You can still get a mortgage with a higher ratio, but your choice of loan and lender will shrink. Though if your DTI is too large, you will likely have to pay down some debts before reapplying.

9. Discount points

When you buy a home, you’re typically offered the opportunity to purchase discount points. You pay an additional cash sum on closing. And, in return, the lender reduces your mortgage rate.

Whether that’s an opportunity you should seize depends on a few factors. For example, many simply lack the money to take advantage of the offer. And the math works differently depending on what’s happening with mortgage rates.

10. Down payment

A down payment is the amount of money you pay upfront when purchasing property.

It’s a myth that you need a down payment of 20% of the home’s purchase price. Most mortgages allow down payments as low as 3% (Fannie Mae and Freddie Mac) or 3.5% (FHA). And a couple (VA and USDA loans) require no down payment at all.

Of course, there are advantages to having a 20% down payment. Most importantly, you avoid mortgage insurance (see below).

Most homeowners find — especially when home prices are rising — they’ve made more money by paying mortgage insurance for a while than they would have had they waited to save up 20%. Indeed, for many, low-down-payment loans are their only possible route to achieving their homeownership dreams.

For how your down payment figures in your lender’s application-approval process, see LTV, below.

11. Escrow

Merriam-Webster defines escrow as “a deed, a bond, money, or a piece of property held in trust by a third party to be turned over to the grantee only upon fulfillment of a condition.”

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For home buyers, it’s typically money held by a neutral party (often an escrow company, attorney or title agent) that’s released on closing. Your earnest money (an initial good-faith deposit you pay when your offer is accepted) is likely to be held in escrow.

Many homeowners also encounter a different type of escrow, sometimes called “impounds.” This tends to happen if you have an LTV (see below) above 80%. The mortgage servicer (the company that administers your account and to which you make your monthly payments) each month collects your homeowners insurance premiums and property taxes as well as your mortgage payment. And it distributes those funds on your behalf.

From closing, at which you make upfront payments, it maintains a cushion of several months of those premiums and taxes. That way, the lender can be sure your home has insurance coverage and isn’t going to be seized by local authorities. And it gets plenty of warning if you find yourself in financial hot water. You may be left to make those payments yourself once your lender has built up more confidence in you.

12. Fixed-rate mortgage (FRM)

A fixed-rate mortgage (FRM) is by far the most common type of home loan. As the name implies, it’s one where the mortgage rate never changes. Because of that, your monthly payment never changes over the lifetime of your mortgage. (See adjustable-rate mortgage, above.)

13. Home inspection

While an appraiser assesses the market value of the home you’re buying, they may not be trained to spot major structural flaws or potential issues the home may have. That’s the job of a home inspector.

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Typically, you won’t be obliged to commission (and therefore pay for) a home inspection. But many home buyers see it as a modest yet worthwhile investment since no one wants to buy a money pit. And home inspections frequently give a buyer grounds to negotiate a reduction in the purchase price that can pay the home inspector’s fee ($280-$401 on average in 2022, according to HomeAdvisor) many times over.

14. Loan estimate

When you’re buying a home, it’s essential to shop around different mortgage lenders for your best deal. In 2023, federal regulator the Consumer Financial Protection Bureau calculated: “Mortgage borrowers are paying around $100 a month more depending on which lender they choose, for the same type of loan and the same consumer characteristics (such as credit score and down payment).”

You can only be sure you’re getting a good deal through a comparison shopping exercise, asking different lenders for quotes. Quotes now come in a standardized format (see sample), making side-by-side comparisons easy. And those quotes are called loan estimates. Knowing how to read them is very helpful.

In the days before closing, you’ll receive a closing disclosure from your chosen lender. That will lay out all the details of your loan, including the exact sum you’ll need to close. This should be very similar to the loan estimate. And your lender must justify any differences between the two.

15. Loan-to-value ratio (LTV)

Your LTV measures the size of your down payment relative to your purchase price — or, more correctly, to the appraised value of the home you’re buying.

So, if you were buying a $100,000 home and you were putting down $3,000, your down payment would be 3% ($3,000/$100,000=3%.). And your loan-to-value ratio would be 97% because your loan would make up 97% of the 100% appraised value (100% price - 3% down payment = 97% loan).

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In other words, your loan would make up 97% ($97,000 in this case) of the purchase price and your down payment ($3,000) would comprise 3%. This scenario is common for Fannie Mae and Freddie Mac loans. While most home prices are much higher than the example above, the math remains the same.

Having a lower LTV than the minimum required for your type of mortgage could make it more likely that your mortgage application will be approved. And it might earn you a lower mortgage rate. But, if your DTI and credit score are within the desired ranges, a minimum LTV will usually be fine, at least for most lenders.

16. Mortgage insurance

If you need a mortgage and you have a down payment that’s below 20% of the home’s purchase price, you’ll normally have to pay for mortgage insurance. There’s an exception for VA loans (almost exclusively for veterans and service members), which require no down payment and have no continuing mortgage insurance payments. And some borrowers may be able to find workarounds.

Private mortgage insurance (PMI) is the term used for loans that conform with Fannie Mae and Freddie Mac’s rules. And you can stop paying that once your mortgage balance drops below 80% of your home’s current market value.

FHA and USDA loans have mortgage insurance premiums (MIPs) instead. They’re the same as PMI in principle, although the premium rates differ. But there’s an important difference. You must continue to pay MIPs throughout the life of your loan: until you sell the home, refinance your mortgage or finish paying it off.

17. Origination fee

Most lenders charge an origination fee for processing and underwriting your loan application. But those fees vary widely.

Often, you can choose between a lower mortgage rate and higher origination costs or vice versa. Check out all the closing costs you’re likely to face and how you can minimize them. You’ll find all these details in your loan estimate (above).

18. Preapproval and prequalification

When you’re setting out to find and buy a home, it’s a good idea to get a preapproval letter from a lender. This will tell sellers and agents that you’re a credible purchaser who has the funds in place to close on an offer.

To get preapproved, your lender will run most of the financial, employment, income and ID checks it would with a full mortgage application. So, sellers and lenders will know you’re the real deal.

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This is very different from — and much more valid than — a prequalification. With one of those, the lender checks your credit but takes your word for most of the rest. So, sellers and agents are often unimpressed by prequalification letters.

19. Title

A title shows the extent of the property, the legal owner and whether there are “liens” (loans secured by it). The title gives you legal rights, ownership control and responsibility for the home. On selling, a title is transferred by a document called a deed.

Very occasionally, a title can be faulty. Some forgotten person or company may still have ownership or usage rights over the home or land.

Because of this, a title search is carried out and you must read that before closing. You’re responsible for any such rights exposed by the search and won’t be covered by the title insurance that protects you only from unknown claims on your title. The title search fee and the single title insurance premium will be included in your closing costs.

20. Uniform residential loan application

As the name suggests, the uniform residential loan application (URLA) is a loan application format used by nearly all lenders. Originally designed by Fannie Mae and Freddie Mac, the form’s purpose is to collect the necessary information to determine whether you’re a creditworthy borrower in a standardized way.

The bottom line

Mortgage terms can be confusing. But all professions use jargon as a shorthand. Knowing your ARM from your elbow empowers you.

Being in the know can help make the home buying process easier, have the confidence to ask crucial questions, and you’ll be able to recognize if a professional is trying to pull the wool over your eyes.

Even knowing just the terms outlined here will better equip you for mortgage shopping. If you’re ready to begin your home buying journey, reach out to a local lender today.

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Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.
Paul Centopani
Reviewed By: Paul Centopani
The Mortgage Reports Editor
Paul Centopani is a writer and editor who started covering the lending and housing markets in 2018. Previous to joining The Mortgage Reports, he was a reporter for National Mortgage News. Paul grew up in Connecticut, graduated from Binghamton University and now lives in Chicago after a decade in New York and the D.C. area.