Home Loan Basics: Products and Terms
When it comes to discussions on home loans, acronyms such as ARM, DTI, FICO, PITI, and IO seem to pop up in every other sentence. Terms like conventional, nonconforming, equity, principal, and amortization are frequently used. Products are described as Nonconforming 5/1 ARMs or Conforming 30-year fixed. Luckily, you don’t need to be an expert in the vocabulary of the mortgage industry to get a home loan. Simply learning a few of the key products, concepts, and terms can give you an advantage when discussing your options for a loan.
Is a home loan the same thing as a mortgage?
Technically, a home loan is the money you borrow from the bank to purchase your home, and a mortgage is the legal agreement you make with the bank for the loan. However, in practice, the terms are used interchangeably by just about everyone inside and outside the lending industry.
What is the difference between a conventional and nonconventional loan?
Loans not backed by the government are conventional loans. Many conventional loans are offered through Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corporation). Although both agencies are government-sponsored enterprises (GSEs), the loans they offer aren’t guaranteed by the government.
In contrast, nonconventional loans are insured or guaranteed by the government agency that offers them. These include loan programs through the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), and Department of Agriculture (USDA).
How do conforming and nonconforming loans differ?
Conventional loans, those not guaranteed by the government, can be further broken down into conforming or nonconforming categories. Conforming loans meet guidelines set by Fannie Mae and Freddie Mac. The loans that don’t meet these guidelines are classified as nonconforming loans. There are many reasons that a loan may not meet the standards of Fannie Mae or Freddie Mac, but a high loan amount is a common one.
What are some common loan products?
Conforming loans are among the most popular home loan products available. In most areas of the United States, the maximum acceptable loan amount for a conforming loan is $510,400 — but this amount can be higher in designated high-cost areas. Conforming loans are a popular choice because they often offer lower interest rates than other loan products.
The VA home loan program helps eligible Servicemembers and Veterans purchase homes or refinance existing mortgages. VA loans are available to active duty personnel, Veterans, Reservists, National Guard members, and certain surviving spouses. Because a VA loan is guaranteed by the U.S Department of Veterans Affairs, in most cases it won’t require a down payment or the purchase of mortgage insurance.
FHA loans are mortgages insured by the Federal Housing Administration (FHA) and are another example of a nonconventional loan. FHA loans are an option for many borrowers who are looking for a low down payment and a lower credit score requirement than available through conventional mortgages.
Jumbo loans are nonconforming mortgages with loan amounts that are larger than those accepted by Fannie Mae or Freddie Mac. Because jumbo loans are considered riskier than conforming loans, they often have higher interest rates and stricter underwriting requirements.
It’s a loan that the lender who loaned the money to the borrower decides to keep in their investment portfolio; hence, the name portfolio loan. By keeping the loan and taking on any risks associated with the loan, the lender determines their own guidelines and terms for the loan.
What are some options I can get with my mortgage?
Loan terms of 30, 20, 15, and 10 years
The loan term is how long you have to repay the home loan. The most common loan term is 30 years, but terms of 20, 15, and 10 years are also available. Loans with shorter terms have higher monthly payments, but may offer lower interest rates.
Fixed or Adjustable Rate Mortgages
As the name implies, the interest rate on a fixed rate mortgage remains the same throughout the loan period. In contrast, the interest rate on an adjustable rate mortgage (ARM) can change periodically during the term of the loan. Typically, the interest rate is set for a certain period — 3, 5, 7, or 10 years. After the fixed-rate period ends, the interest rate may adjust up or down annually based on a designated index in the financial markets.
An interest-only loan allows the borrower to pay only the interest on the loan during the initial period of the loan, often 5 to 10 years. Once the interest-only period ends, the borrower’s payments increase to cover interest plus some of the principal balance during the final period.
What are some common mortgage terms?
Amortization is the process of repaying a loan over a set number of years through fixed monthly payments. Part of each payment is for interest while the remaining amount is used to reduce the principal balance. Initially, a large portion of each payment goes to interest. However, over time an increasing amount goes towards paying down the principal balance.
Debt-to-income (DTI) ratio
A debt-to-income ratio is the percentage of a borrower’s monthly gross income used to pay reoccurring monthly debts. It is a tool lenders use to evaluate a borrower’s ability to repay a mortgage. The acceptable maximum DTI ratio will vary between loan programs and lenders.
PITI is an acronym for the total amount you will pay in principal, interest, taxes, and insurance each month. Your mortgage payment represents the “principal” and “interest” in this calculation. Annual property tax is broken into a monthly amount to represent the “tax” amount. “Insurance” stands for the monthly amount needed for homeowner’s insurance (and private mortgage insurance, if applicable). The lender uses PITI to calculate DTI ratios.
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is a type of insurance that protects the lender if the borrower stops making mortgage payments. It’s generally required when a borrower uses a conventional loan to purchase a home and makes a down payment of less than 20 percent.
An escrow account is often set up by mortgage lenders to cover property-related expenses. When calculating your total monthly mortgage payment, the lender adds an amount to cover property taxes and insurance premiums — in addition to the principal and interest amounts. The additional money goes in an escrow account until these expenses come due and are paid by the lender.
Tri-merge credit report
A tri-merge credit report is a single report that merges all the credit data available from the three major consumer reporting agencies — Experian, Equifax, and TransUnion. The credit score from each agency is listed individually on the report, instead of being merged or averaged together. The report shows information on your current and past credit accounts, a list of who has recently pulled your credit report, and any bankruptcies or past-due accounts.
Underwriting is the process your lender uses to ensure you meet all the requirements of the loan program and to assess your ability to repay the loan. The mortgage underwriter will look at the documents you submitted, your credit history, income information, and debt-to-income (DTI) ratios, among other things. You may be asked to submit additional documentation or a letter of explanation for anything unusual on your credit report. The time this takes can vary from a few days to a few weeks.
Is being pre-qualified for a loan the same as being pre-approved?
A pre-approval is the second step in the loan process and is more involved. Borrowers are asked to complete an official mortgage application, provide income and asset documentation, and allow the lender to run a credit report. Because a pre-approval letter is based on information that can be verified, it carries more weight than a pre-qualification letter.
What are some reasons to refinance an existing mortgage?
There are many reasons to refinance a mortgage. The most common reason given is to lower the interest rate. Getting a lower interest rate can also mean a lower monthly payment. Borrowers who have an adjustable rate mortgage (ARM) may benefit from a refinance that locks in a fixed interest rate. Another reason borrowers choose to refinance is to pay off other high-interest debts. A mortgage refinance can also be used to remove or add borrowers to the mortgage or title.
Learning these common products and terms will allow you to speak the distinctive language of lending. With this newfound vocabulary, you can be confident in talking with your lender about your options for a home loan.
Whether purchasing a home or refinancing an existing mortgage, you can rely on the mortgage professionals at Axos Bank to guide you through the home loan process. To speak with an experienced mortgage specialist, please call us at 888-546-2634.
This blog post was published by Axos Editorial Team on February 12, 2019 and last updated on February 12, 2019.