6 Key Home Buying Terms Made Clear
If you’re buying a home for the first time, familiarizing yourself with the wealth of information available is often a welcomed challenge. Learning all of the terms and procedures relevant to your eventual closing process can be exciting and motivating. It’s a lot to learn, but once you understand the terminology and how it relates to your home buying experience, you can proceed confidently. Here are some key terms and definitions you will may encounter during your home buying process.
When you sign a typical 30-year fixed interest mortgage, the 30 years is your amortization period. Each month, a portion of your mortgage payment goes towards paying interest, and another portion goes toward paying down the principal amount. As the principal loan amount decreases, the portion of your payment going to interest each month decreases with the principal amount increasing at the same rate.
A common misconception is that equity is the difference between the purchase price of your home and your current principal balance. In fact, equity is the difference between your home’s current market value and your balance. As you pay your principal down over time, your equity increases. However, your equity will fluctuate with the current value of your home. Another important relationship to understand is that as your home rises in value, your equity also rises.
Also known as private mortgage insurance, PMI is insurance purchased, usually by the borrower, to insure the lender if the borrower defaults (fails to pay back) on the loan. PMI allows lenders to safely underwrite loans with as little as 5% down knowing that even if the borrower cannot make the payments, a significant portion of their losses will be covered. Typically, a lender will require that PMI remain in place until the lender has achieved 20% equity in their home. If home values are rising and you are near that 20% mark, it may benefit you to have the home appraised to determine if your equity has exceeded 20%, allowing you to cancel the PMI payments.
To ensure that the borrower is able to make the yearly tax and insurance payments, lenders require that the estimated yearly cost be broken up into 12 monthly payments, which are added onto the borrower’s mortgage payment. Each month, this money goes into what is known as an escrow account. This amount is held by a third party until the tax or insurance payment is due, at which time the escrow disburses the funds to the servicer. Because insurance and tax amounts can change from year to year, the amount paid in escrow may change, resulting in a different mortgage payment amount owed by the lender.
Principal, interest, taxes, and insurance. These are the four components that make up your total monthly mortgage payment, usually known as PITI.
The loan servicer is the organization that sends your mortgage statements, and to whom you make your monthly loan payments. The servicer may not be the same as the company you received your loan from originally, and may change over the life of the loan. The servicer also distributes the payments for insurance and taxes.
Understanding key terms can go a long way toward making the process of homebuying easier and more enjoyable. We also recommend working with knowledgeable advisors like those at HOMEteam to assist you in making the right financial decisions. HOMEteam helps first time home buyers navigate the mortgage process, renters save for home ownership, and home owners preserve and protect their investment in their home. Contact us to get the guidance and educational tools to help you transition from buyer to owner with confidence.
HOMEteam is an independent organization dedicated to providing consumers with objective tools and information that will help them prepare for and protect their biggest investment – their home. Through a series of workshops, one-on-one counseling, and other resources, HOMEteam helps first time home buyers navigate the mortgage process, renters save for home ownership, and home owners preserve and protect their investment in their home.
Whether you’re a renter, a first-time home buyer or a long-time homeowner, HOMEteam is here to help. Contact us today to get started!