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 also 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 mortgage industry vocabulary 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.
We’ve rounded up common mortgage questions to help you learn about home loan products and terms.
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, the terms are used interchangeably by nearly 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, 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, Department of Veterans Affairs, and Department of Agriculture.
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 a loan may not meet Fannie Mae or Freddie Mac standards, including a high loan amount.
What are some common loan products?
Lenders can create their own unique loan products. But there are some that are widely available and offer similar features from lender to lender. Here are some of the most common loan products.
Conforming Loans
Conforming loans are popular because they often offer lower interest rates than other options. They’re limited to a maximum loan amount, which is adjusted each year. As of 2022, the maximum In most areas of the United States, the maximum acceptable loan amount for a conforming loan in most areas of the United States is $647,200 — but this amount can be higher in designated high-cost areas.
VA Loans
The VA home loan program helps eligible service members 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, it often doesn’t require a down payment or the purchase of mortgage insurance.
FHA Loans
FHA loans are mortgages insured by the Federal Housing Administration. FHA loans are an option for many borrowers who are looking for a lower down payment or credit score requirement than what’s available through conventional mortgages.
Jumbo Loans
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 more strict underwriting requirements.
Portfolio Loans
Portfolio loans are funded by banks and private investors, allowing the lender to build flexibility into the loan because it’s not tied to external agency standards. By keeping the loan and taking on any associated risk, the lender determines their own guidelines and terms for the loan.
What are some options I can get with my mortgage?
Lenders can create their own unique loan products. But there are some that are widely available and offer similar features from lender to lender. Here are some of the most common loan products.
Loan Terms of 40, 30, 20, 15, and 10 Years
This is how long you repay the home loan. The most common loan term is 30 years, but terms of 40, 20, 15, and 10 years are also available, dependind on the lender. Loans with shorter terms have higher monthly payments but may offer lower interest rates.
Fixed- or Adjustable-Rate Mortgages
The interest rate on a fixed-rate mortgage remains the same throughout the life of the loan. 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 an initial period: 3, 5, 7, or 10 years. After the fixed-rate period ends, the interest rate may adjust up or down periodically based on a designated index.The adjustment period is typically once a year or every six months and is outlined in the details of the loan.
Interest-Only Loan
With an interest-only loan, you start with smaller payments that only cover interest. This initial payment period is for a set amount of time, often five to 10 years. Once the interest-only period ends, your payments increase to cover interest and the principal for the remainder of the loan.
What are some common mortgage terms?
Amortization
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. Over time, an increasing amount goes towards the principal balance.
Debt-to-Income (DTI) Ratio
A debt-to-income ratio is the percentage of your monthly gross income used to pay reoccurring monthly debts. It helps lenders evaluate your ability to repay a mortgage. The acceptable maximum DTI ratio varies between loan programs and lenders.
PITI
PITI is an acronym for the total amount you 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 is for the monthly amount needed for homeowner’s insurance (and private mortgage insurance, if applicable). The lender uses PITI when calculating DTI ratios.
Private Mortgage Insurance (PMI)
Private mortgage insurance protects the lender if you stop making mortgage payments. It’s generally required if you get a conventional loan with a down payment of less than 20%.
Escrow Account
An escrow account is often set up by mortgage lenders to cover property-related expenses, such as property taxes and insurance premiums. They calculate how much will be needed for the year and break it into a monthly amount.
This is added to your monthly mortgage payment. The funds are deposited into the escrow account until these expenses are paid by the lender.
Tri-Merge Credit Report
A tri-merge credit report is a single report that includes all the credit data available from the three major U.S. consumer reporting agencies — Experian, Equifax, and TransUnion.
The credit score from each agency is listed individually on the report. The report shows your current and past credit accounts, a list of who has recently pulled your credit report, and any bankruptcies or past-due accounts.
Underwriting
Underwriting is the process your lender uses to ensure you meet loan program requirements and can repay the loan. The mortgage underwriter looks at the provided documents, your credit history, income information, and DTI ratios, among other things.
You may be asked to submit additional documentation or a letter of explanation for anything unusual in your credit report. This can take a few days to a few weeks.
Is being pre-qualified for a loan the same as being preapproved?
Although they sound similar, they’re actually two different steps in the mortgage process. Having a fully underwritten preapproval carries more weight when it’s time to make an offer on a house.
Getting
pre-qualified comes first. You supply the lender with your income, assets, and
debt information, and then you receive a letter with an estimate of how
much you can borrow. This estimate is based entirely on the information
you provide.
A preapproval is the second step in the loan process and and includes an in-depth review of your financial situation. You’re are asked to complete an official mortgage application, provide income and asset documentation, and allow the lender to run a credit report.
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 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 and doesn’t have to be complicated.
Why should you learn mortgage vocabulary?
Learning these common products and terms will allow you to speak the distinct language of lending. With this newfound vocabulary, you can be confident in talking with your lender about your options for a home loan. Take a look at the remaining articles in our four-part Home Loan Basics series, such as Reasons to Refinance.
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 August 9, 2023
