Do You Know These Five Common Mortgage Terms?

Getting a loan can be an intimidating process. Between the vast amount of numbers and the specific industry jargon there are times when you can feel overwhelmed. A good mortgage broker or loan officer will constantly put you at ease and help you feel in control of the process. That being said, it is always better to know what you are getting into prior to starting the process. A refresher on some basic loan jargon can not only help put you at ease but may even lead to a better deal. Regardless if you only use traditional lenders for specific deals, you never know when they may make the most sense. By knowing your loan terms and jargon you will be confident to act and ahead of the game. Here are five common loan terms and a quick definition for each.

• Interest Rate Vs. Annual Percentage Rate:  A lot has changed in the mortgage industry over the last decade. In the past, it is far too common to show up at the closing table not fully knowing what you are signing. Many times, the numbers you discussed were different than the final numbers. This all changed with the mortgage collapse. Today, there are checkpoints and safeguards in place to guarantee that your initial numbers are the same, or in a close range, to the final numbers. One of the biggest questions in the process is the difference between the interest rate and the annual percentage rate. Your interest rate is the only number that really matters. The interest rate determines your monthly payment. The annual percentage rate (APR) is the cost of credit as an annual rate. It factors in the interest rate, lender fees, closing costs and other certain fees. The APR will be higher than your interest rate, but it is often a misleading number.
• Balloon Mortgage: It is no secret that adjustable rate and balloon mortgages where blamed for a good portion of the mortgage collapse. While there were certainly a good number of ARMs that defaulted, if used the right way they could be a great loan product. Before you commit to any loan you should take a minute to evaluate your short- and long-term goals. When you are in the middle of the process it is easy to get enticed by a lower interest rate and monthly payment. A balloon mortgage can make sense, in the right situation. A balloon loan has a shorter balloon term but is still spread out (amortized) over the term of the loan. So, you can have a balloon loan that is repaid over 30 years but fixed for only the first seven years of it. After the seven years the loan is immediately due and must be repaid. You would never want to take a balloon on a rental property or primary residence where you think you will retain ownership for the foreseeable future. A balloon is best used for a property you want to keep your payment as low as possible and sell or refinance prior to the balloon coming due.
• Equity: Equity is the driving force behind most new home purchases and ownership. Equity is the simply the difference in the property value and the amount owed. If you owe say $100,000 on a property and the value is $150,000 you have $50,000 in equity. It is important to remember that equity is in a sense a moving target. Local sales and market conditions constantly change and impact value. It is also a bit of an estimate. You never really know the value of a property until you put it on the market and let demand decide. For purchasing purposes your equity is based on the sales price. If you put down 10%, you start with 10% equity when you move in. The biggest way to improve your equity is by making timely updates and improvements to the property.
• Home Equity Line Of Credit (HELOC): Increased equity gives you increased options. If your property has equity and you want to tap into it there are ways to do so without selling. You can attach a second loan behind the existing first loan with a HELOC. A HELOC is an adjustable rate mortgage based on a prime index. Your payment will change from month to month. You will receive a twenty-year term with the first ten years having an interest only option. The remaining ten years you must pay the principal and interest on whatever is owed. A HELOC is often great for people who want to keep their payments low and are willing to make large periodic payments. Borrowers who have income that fluctuates are often great candidates for a HELOC. Keep in mind that with a HELOC your first mortgage stays in place and all you are doing is adding a separate second lien.
• Debt To Income (DTI): There are always a few things you should do if you are considering taking out a new loan. The first is to pull a copy of your credit report. This will give you an idea of your score and what you can do. The second is to calculate your debt to income ratio. If you have a credit report, you can simply add all the minimum liability payments in addition to your proposed monthly mortgage payment. Next, you need to divide your gross annual income by twelve to get your monthly income number. You then divide your liabilities by your income and that is your DTI. This number generally needs to be under 50%, but in some cases as low as 43%.

Some basic understanding of loan terms and how they are used can help change the way you view your mortgage. The more you know the easier it is to act.