Mortgage Jargon in Simple Terms

mortgage documentObtaining a mortgage loan means dealing with a lot of paperwork, from the documents you have to submit to documents you have to read and sign. More often than not, you're dealing with terms and conditions on various mortgage types that may be so difficult to understand that you just want to pull out your hair. But not understanding the terms of the loan could mean a very costly mistake on one of the most expensive purchases you'll ever make.

So before you sign on the dotted line, you should learn some basic mortgage terminology to keep your eyes from glazing over when you hear words like "amoritization" and "PITI." To help you tackle them, here's our guide to the top mortgage terms you need to know.

Adjustable rate mortgage: A mortgage loan with an interest rate that will change or "adjust" periodically, such as every three years or annually after the fifth year, changing the monthly payment due. ARMs are best if you plan to sell the home before the rate adjusts. (See "How to Pick the Right Mortgage Product for You.")

Amortization: The schedule for paying off a mortgage loan, showing the regular, required payments toward principal and interest over a set period of time. AOL Real Estate's mortgage calculator shows you an amortization table.

Credit score: A number between 300 and 850 used to show creditors and lenders the creditworthiness of a potential loan borrower. The score, determined by credit bureaus such as Equifax, Experian and TransUnion, is calculated through an analysis of a person's borrowing and repayment habits. How timely you are paying bills or how much revolving credit card debt you have can affect your score. The higher the score, the better. (See "Credit Scores and Home Buying.")

Equity: The value of a property minus the remaining mortgage balance. Equity is gained or lost by the appreciation or depreciation in the market value of the property. It is also typically gained as payments toward principal are made on the mortgage loan. You can rapidly increase your equity, and shave off tens of thousands in interest, by making one extra mortgage payment a year in a lump sum or paying a little more each month.

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Fixed-rate mortgage: A conventional mortgage loan that has an interest rate and monthly payment that remain the same for the life of the loan (typically, 15 or 30 years, but 40-, 50- and 10-year loans are possible). A 15-year mortgage offers quicker repayment for faster equity buildup, usually at a lower interest rate than longer term mortgages. A fixed-rate mortgage is usually your safest financial choice. (See "How to Pick the Right Mortgage Product for You.")

Home equity loan: A loan or second mortgage that a borrower can take out against the equity in a home, essentially trading equity for cash. The interest paid on a home equity loan is tax deductible.

Home equity line of credit: Similar to the home equity loan, but instead of getting all the money at once, the borrower is essentially approved for a certain amount that can be withdrawn in increments, using a check book or debit card, up to a limit.

Interest-only mortgage: Allows buyers to pay just the interest on a mortgage at the beginning of the loan, then after a set period, typically a year or less, payment toward the principal is also made, at which time the minimum monthly payment typically increases. (See "How to Pick the Right Mortgage Product for You.")

Jumbo loan: A non-conforming loan, or "jumbo mortgage," that is larger than the home loan limits that Fannie Mae and Freddie Mac are willing to back, or guarantee, because they are considered risky. Jumbo loans have slightly higher rates than conforming loans. (See "How to Pick the Right Mortgage Product for You.")

Loan origination fees: Sometimes called "points," are loan application processing fees equal to 1 percent of the loan amount. Do not confuse these fees with mortgage points. (See "Closing Costs: How Much to Budget").

Lock or lock-in period: The timeframe in which a loan cannot be paid off earlier than stated without financial penalty, so that the lender is assured of obtaining a certain minimum return on the investment. This also refers to how long a lender has agreed to hold a quoted interest rate unchanged on the loan, regardless of whether the going market rate increases before the final paperwork is signed. The rates are usually held, or "locked in," for anywhere from 30 to 90 days.

Mortgage insurance: Protects the lender should the borrower default on the loan. The insurance is typically issued by the FHA or a private mortgage insurer. In the latter case the insurance is known as "PMI." Mortgage insurance is usually required if the homebuyer borrows more than 80 percent of the market value or purchase price of the home. If you need PMI, note that it can be canceled once you reach 20 percent equity in your home, either through price appreciation or by paying down the principal balance for your loan. You'll have to make your request in writing to the mortgage lender.

Mortgage points: Lender's fees or advance interest that a borrower pays up front in exchange for a lower interest rate for a certain part of the loan term, often over the life of the loan. Also known as "discount points," these points are based on a percentage of the loan, with each point being equal to 1 percent of the loan. So, one point costs $2,000 for a $200,000 mortgage loan. (See "Closing Costs: How Much to Budget.")

PITI: Pronounced "pity," it is an acronym for principal, interest, taxes and insurance, the four components of a mortgage payment.

Pre-payment penalty: A fee assessed by a lender as a charge to a loan borrower who makes an advanced payment or pays off a loan earlier than the due date or payment terms in the agreement. The penalty fee compensates the lender for the loss of some of the interest that would have been earned, had the loan continued for its full term.

Principal: The part of a monthly loan payment that reduces the outstanding balance of a mortgage, and becomes the equity for the borrower. By making extra payments toward your principal on a monthly or annual basis, you can greatly reduce how much interest you pay over the life of the loan.

Qualifying ratios: Calculations that the lenders use to determine the largest mortgage that a homebuyer can afford to obtain, or that the lender is willing to approve. (See "How Much Home Can I Afford?")

Refinancing: The process of obtaining a new loan to replace an existing loan. Typically this is done to reduce an interest rate or to extend the loan over a different period of time (for instance, starting again at 30 years or down to 15 years). It is done either to lower monthly payments, pay off a debt sooner, switch an adjustable rate mortgage to a fixed rate one, or obtain some cash back. (See "When to Refinance.")

For more on mortgages and real estate terms see these AOL Real Estate guides:

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