Confused about mortgages? These key terms will guide you
What's the story
Navigating through the labyrinth of mortgages can be intimidating for first-time homebuyers.
However, understanding certain key terms is critical to making informed decisions.
With that in mind, we attempt to demystify some key mortgage-related terminologies, so that you stride ahead in your home-buying journey with more confidence.
Let us take a look at them.
Term #1
Principal and interest
The principal is the original amount you borrow from a lender, while interest is what you pay to borrow that money.
When you pay monthly mortgage payments, part of the payment goes toward reducing the principal, while another portion pays for interest charges.
Over time, as you pay down the principal, lesser of your payment goes toward interest. Knowing this is key to planning how fast you can pay off your loan.
Term #2
Fixed vs Adjustable Rate Mortgages
A fixed-rate mortgage offers a consistent interest rate for the life of the loan, ensuring predictable monthly payments.
Alternatively, an adjustable-rate mortgage (ARM) begins with a lower initial interest rate that may fluctuate periodically depending on market conditions.
Although ARMs may provide lower initial rates, they come with the possibility of higher payments over time if rates increase.
Term #3
Loan-to-value ratio
The loan-to-value (LTV) ratio measures how much loan you're taking out compared to the appraised value of a property.
A lower LTV ratio often yields better loan terms as it denotes less risk for lenders.
For instance, if you're purchasing a home worth $200,000 and take a loan of $160,000, you'd have 80% LTV.
Knowing your LTV ratio helps evaluate how much equity you'll have in your home.
Term #4
Private Mortgage Insurance
Private Mortgage Insurance (PMI) protects lenders when borrowers put down less than 20% on a home purchase.
It adds to monthly costs, but lets buyers secure loans with smaller down payments.
Once enough equity is built up—typically when reaching 20%—PMI can often be removed upon request, or automatically canceled by lenders at certain thresholds.
Term #5
Prepayment penalties
Some mortgages have prepayment penalties.
These are for paying off loans early or making extra payments over scheduled amounts within specific periods after closing.
These penalties are to compensate lenders for losing interest revenue if a borrower pays off a loan early (by refinancing) or sells a home sooner than expected.