Think you have a pretty good idea about what it takes to buy a home? We’ve compiled a list of financial terms that could use some clarification, even if you’re somewhat familiar with them. These terms are spoken quite a bit by mortgage lenders, real estate agents, and title companies. Better to understand them upfront before conducting a serious home search.
Preapproval
A preapproval is a preliminary evaluation of a borrower by a lender to determine whether they can qualify for financing a home in a particular price range. The process is usually the very first step a home buyer needs to take. A lender reviews your income, assets, and credit and might ask for documentation such as bank statements and pay stubs. It is critical to get preapproval to show that you qualify for financing. Not only does it give you a realistic picture of what you can afford to buy, it’s a necessary step to work with an experienced real estate agent. Many agents won’t start showing homes to you until preapproval is complete, because it is required proof when making an offer.
Debt-to-Income Ratio
Debt-to-income ratio is your monthly debt payments divided by your gross monthly income. Lenders use this number to measure your ability to manage the monthly payments to repay the money you plan to borrow from them. Let’s say all your monthly debt payments equal $2,000 and your gross monthly income is $6,000. That makes your debt-to-income ratio 33% (2,000/6,000). Most lenders will not lend to people with DTI ratios above 43% as it indicates an increased risk that the borrower will fall into payment trouble.
APR
APR stands for Annual Percentage Rate. While some buyers may think APR and their mortgage interest rate are the same, that’s usually not true. Your interest rate is the rate of interest charged on the principal of the loan. The APR is a broader calculation of the cost of borrowing money. It includes all the charges to buy a home, including interest rate, closing costs, lender fees, and insurance.
Escrow
Escrow is a legal arrangement in which a third party temporarily holds a large amount of money until a specific condition has been met. When financing a home, the lender will likely require an escrow account to hold funds for property taxes and home owner’s insurance throughout the life of the loan. Escrow ensures that these fees are paid on time without late fees, penalties, and liens against your property.
Earnest Money
When you first write an offer with a purchase contract, you’ll want to include a check for a dollar amount that shows you’re putting forth a serious commitment to purchase. The amount varies based on local real estate markets. Your real estate agent can tell you typical expectations. Ultimately, the amount is your decision to make. The money is used as a deposit that is credited toward your down payment or closing costs when you close on the home. Should your offer be declined or financing falls through, earnest money is returned to you. Ask your real estate agent about possible instances where you could lose earnest money.
Closing Costs
Beyond your down payment, closing costs are an additional payment that is due when you close on a home. Typical fees that show up in closing costs are loan origination fees, appraisal and survey fees, title insurance, home owner’s insurance, private mortgage insurance, mortgage points, escrow fees, attorney fees, and other miscellaneous fees. Closing costs usually add up anywhere from 3 to 5% of the loan amount. For this reason, many buyers include the amount in the financing of their loan.
Real Estate Term of the Week
Appraisal: The estimated value of a home determined by an inspection of the property and its comparison to recently sold homes in the area to estimate the value. It’s intended to protect the buyer from paying more than the home is worth. In both a purchase and a refinance, it prevents the lender from giving the home owner more money than the home is worth.