Ten Basic Terms, Explained for a Six-Year-Old
If you’re getting ready to buy your first home, you may feel a little intimidated by all the specialized language surrounding the process. Failing to understand some of the terms could end up being quite expensive, so it’s important to get educated on the process before you begin. With that in mind, here is a quick guide to ten basic mortgage terms, explained in language that any reasonably intelligent six-year-old should be able to understand.
1 – Adjustable-Rate Mortgage (ARM)
An ARM is a home loan with an interest rate that can change, depending on federal interest rates. The interest rate usually has a cap to make sure that it doesn’t go up too much, no matter what happens to the economy.
2 – Fixed-Rate Mortgage
A fixed-rate mortgage is a home loan with a solid, unchanging interest rate. If you get one of these, you may want to refinance later if interest rates go down, but you won’t have to worry about them going up.
3 – Balloon Payment
A balloon payment is a big payment that you have to make at the end of a loan in order to pay off the remaining balance. These can lower your monthly payments, but can also force you into refinancing or extending your mortgage if you can’t come up with the big payment required at the end.
4 – Closing Costs
Closing costs represent all of the costs of going through the home-buying process (ie. lawyers fees, taxes, title insurance, escrow payments) that aren’t covered in the purchase price of the house. Your lender should provide you with a good-faith estimate of what these will add up to.
5 – Escrow
Escrow is an extra account that holds all the money and documents that make up a property transfer until the sale is complete. Escrow can also be an account that holds property taxes and insurance money until they are due, like a savings account you pay a little into with each mortgage payment.
6 – Interest-Only Mortgage
This is a mortgage, usually one that features an adjustable interest rate, allowing you to pay only for the interest on your loan for an introductory period. These are often a bad idea, especially in a market where interest rates are rising quickly and the mortgage is an adjustable rate loan.
7 – Equity
Equity is the amount of a property’s value that is owned by the property owner. It can grow through improvements to the property, growth in the market, and through making mortgage payments that go towards the principal of the loan.
8 – Margin
The margin is how many percentage points will be added to the federal interest rate to determine your interest rate on an adjustable rate mortgage or ARM.
9 – Prepayment Penalty
A prepayment penalty is a fee that you might have to pay if you want to pay off your mortgage early. Not all home loans have these.
10 – Private Mortgage Insurance (PMI)
Private mortgage insurance, or PMI, is an insurance policy that protects the bank or loan company from the losses they would incur if you were to default on your mortgage payments. The lower your credit and down payment are, the more likely you will be to pay for this type of insurance.
There You Have It: Mortgages “Explained”
The above list represents ten of the most common mortgage-related terms explained in clear, simple language. Hopefully that will be enough to put your mind at ease. Remember: your real estate agent and lender are working for you, so make sure that you always get a reasonable and thorough explanation of anything you don’t understand before you sign.
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