When applying for your first mortgage, you are going to hear many terms tossed around that are specific to the real estate and financial industry. These terms are not hard, so don't be concerned. If you are not dealing with financial information and real estate on a daily basis, you may not have learned what all the terms mean. Sure you may have heard them before but were never explained the specifics.
Loan to value ratio- This is a ratio that the lender who is financing your mortgage uses to determine how much he or she can loan you. It is determined by dividing the loan amount by the market value of the home in consideration. The market value is often determined by appraisals that evaluate the property and comparable homes that have sold in the immediate area.
Most lenders will loan up to 80% of the market value of a home. If the lender were to loan more than that, the lender would be risking not being able to recover the loaned funds if the property were to go into foreclosure. However, there are lenders who will loan more than 80% of the market value in exchange for a higher interest rate. You will be paying more in interest in exchange for their increased risk of loaning more money than what would normally be acceptable.
Points - This term refers to interest costs paid to the lender in exchange for a lower interest rate. Points are paid one time and are usually equal to one percent of the loan principal. It is not always a good idea to pay one-time points for a lower interest rate. This is where lenders can make a lot of money, and many times points are not even needed in a deal, and are just a bonus for the lender. Be sure to always do the math for each mortgage option to see what will cost you the least amount of money. Also shop around to see what a comparable contract is so you do not overpay.
Interest rate- The interest rate is a yearly rate that is charged on the principal of the loan amount provided by the lender. The principal accrues interest and you must pay it as an exchange for borrowing the money. Interest rates can be very different depending on the type and terms of a mortgage.
The interest rate charged in exchange for borrowing the money has a base percentage dictated by a national index and then percentages are added to this according to the amount of risk the lender is taking by giving you the money to finance the house. The lender should show you the breakdown of the final interest rate charged so you know why the number is what it is. If the lender does not do that, there could be some shady dealing going on and you should consider going somewhere else. Have all the parts of the interest rate disclosed so you know where your money is going and how you are being charged.
Loan term- This is how long you have to pay back the money borrowed from the lender. Common mortgage terms are 5, 7, 10, 15, 20, 25 and 30 years. The loan term is always negotiable depending on how much you need to borrow, what monthly payments you can make, and the amount of interest you will have to pay.
Debt service coverage- This is a ratio that a lender uses to see the borrower's (you) ability to pay back the loan in monthly installments. The ratio is found by dividing your net income by debt. Lenders generally look for debt service coverage ratios of 1.2. This ratio compares the amount of debt to your income. The more income you have to cover your total debt, the better. This ratio shows the lender you are capable of paying the mortgage in addition to your other current debt.
Use this information to get educated and make your first time home buying experience a good one! These terms are specific to mortgage characteristics. For more information on other topics regarding first time home buying, check out the resource box where you can find more information that will help you with buying your first home!