Mortgage hunting and its subsequent interactions come spattered with cryptic financial jargon. If words like “escrow” or “amortization” weren’t hard enough to understand, try navigating the plethora of acronyms that you’ll have to memorize, too. Guess what? ARM isn’t an appendage in finance-speak…even though owning a home can cost the proverbial arm and leg.
In other words, mortgages are confusing and chock-full of terms that the average Joe might not know off the top of their head.
If skimming through mortgage-related literature of either the digital or print variety feels like reading a foreign language, you’ve come to the right place. Read on to learn what terms like “escrow,” “amortization,” and ARM really mean.
Acronyms 101
When you venture across the web-wide world of finance or real estate, you’re bound to get bombarded with what seems like a million acronyms. With that comes the obligatory million tabs you open on Google looking up what “PITI” or “VOE” means. Inconvenient.
Here are the most common mortgage-related acronyms you’ll come across and their clear-cut definitions:
APR – Annual Percentage Rate
Annual percentage rates are often confused with interest rates. While the APR does include the interest rate of your loan, it also consists of the fees that you may have to pay to take out the loan. These fees may include discount points, closing costs, broker fees, and rebates.
ARM – Adjustable Rate Mortgage
An adjustable-rate mortgage is a type of home loan whose interest is fixed—or invariable—for some time, and then changes, or becomes variable. If you acquire a 5/1 ARM, it means that for the first five years, the loan’s interest rate will remain the same. If you choose to take out a 7/1 ARM, the interest rate will stay the same for seven years before possibly changing every year after that.
COE – Certification of Eligibility
Certifications of eligibility are often required for VA loans. A COE verifies whether or not a veteran is eligible to obtain a mortgage backed by the Department of Veterans Affairs.
DTI – Debt-to-Income Ratio
A debt-to-income ratio measures the borrower’s debt (money the borrower owes) to their gross income (money the borrower earns before taxes). If a borrower has a low DTI, like 5%, that means that only 5% of their income goes towards their monthly debts, which makes them a favorable mortgage candidate.
FICO – Fair Isaac Corporation (credit score)
A FICO score is a summary of your credit report. Your FICO credit score is represented by a number ranging from 300-850 that determines your likelihood to repay a loan. The lower your score, the lower your chances of procuring a mortgage or other lines of credit are. Typically, a satisfactory credit score exceeds 670.
LTV – Loan-to-Value
A loan-to-value ratio compares the size of the borrower’s loan compared to the value of the home they want to purchase (or the size of the downpayment). So, if you wish to purchase a home worth $100,000 and you put down $30,000, you will need a $70,000 loan. Your LTV would be 70%.
PITI – Principal, Interest, Taxes, Insurance
The PITI includes the four main segments of your monthly mortgage payment. The principal is your loan amount. The interest is the rate at which your loan is financed. Taxes are real estate taxes. Insurance is homeowners’ insurance that you’re required to have.
PITIA – Principal, Interest, Taxes, Insurance, and Association Dues
PITIA includes everything the PITI contains, in addition to association dues. Association dues are fees you would pay if you reside in a community that provides amenities such as a spa, pools, yard maintenance, sports courts, etc.
P&L – Profit & Loss Statement
A profit and loss statement is a record of a businesses’ revenues (profits) and expenses (debts/losses) over a given period. This document helps lenders determine whether or not the borrower has the ability to repay the loan.
VOE – Verification of Employment
Verifications of employment are used to review borrowers’ employment history to determine their financial stability. They are also used to cross-reference and confirm that their income is the same as stated on their loan application.
Terms 101
Once you’ve mastered the meanings of those common acronyms, it’s time to tackle terms. Not only is it incredibly useful to know what these words mean, but you can also stash a few Scrabble winners up your sleeve.
Amortization
Amortization is a method used to adjust your monthly mortgage payments by altering the principal to interest ratio over time. When you begin to pay a mortgage, the majority of your payment will contribute to interest, while a small portion of your payment goes towards your principal amount. As you continue to make payments, this balance will shift. As you near the end of your mortgage, your interest payments will be low while your principal payments will be high.
Appraisal
An appraisal is a process of determining the actual value of a home by examining the property and comparing its selling price to other homes in the neighborhood. Before applying for a loan, you must get the home appraised to determine the correct amount of money you need to borrow.
Cash Reserves
A cash reserve is the amount of money a buyer has after paying the downpayment and closing costs of a home.
Collateral
Collateral is essentially a different word for a security deposit. Lenders take a risk in lending because they might not get their money back. So, to ensure that the lender is repaid, the borrower will have to provide collateral. In the case of mortgage loans, the home that the borrower wants to purchase is used as collateral. If the borrower fails to repay the loan, the house will then belong to the lender.
Equity
In real estate, equity means ownership; it refers to the amount of money you’ve paid towards the principal of your home. If you have a $100,000 home and you’ve paid $70,000 in principal, you have $70,000 in equity, meaning you own 70% of your home.
Escrow
Escrow refers to using a “third party” to hold something valuable, like a downpayment for a home. The “third party” is neither the buyer nor the seller of a home to reduce transactional risk. Escrow ensures that both the buyer and seller meet their signed contractual obligations (like completing inspections or resolving objections).
Lien
In the world of real estate, a lien is a legal claim to property. Liens are meant to provide security to the lender. Liens can give lenders the legal right to claim your property if you don’t repay the debt that you owe them.
Mortgages can be confusing. Don’t let technical jargon intimidate you. Know the difference between ARMs and legs and keep this list handy the next time you need to do a little house hunting.
