Top 12 Confusing Mortgage Terms Explained
Don’t let these puzzling mortgage terms get the best of you.
We all have those mortgage terms we’re just not sure about. They’re words we hear every now and then but, if we’re honest with ourselves, we’re not entirely sure what they mean. You could reach for a dictionary, but then you’d be missing out on our super simple, easy-to-grasp explanations. Read on to have 12 confusing mortgage terms explained.
12 confusing mortgage terms explained
An adjustable-rate mortgage is a mortgage with an interest rate that adjusts periodically, after it has stayed at the same rate for a certain amount of time. Sometimes abbreviated ARM, an adjustable-rate mortgage usually starts with an interest rate that’s lower than that of a fixed-rate mortgage, but it changes over time based on the index and margin. To some borrowers, this option may seem risky, and many borrowers prefer a fixed rate because they get to enjoy consistent monthly payments (which can help simplify budgeting). But for other borrowers, an adjustable rate means a possibly lower rate, which can result in lower monthly payments during those favorable market times.
One of the most commonly confusing mortgage terms, amortization is the process of paying off your mortgage in planned, incremental payments. For mortgages, this is often displayed in a table, called an amortization schedule, and shows your estimated monthly payment, the interest portion of your payment, the principal, your remaining balance, and more. You might see this among your closing documents when you buy a house. Amortization is a great way to estimate how much you’ll pay over the course of your loan and helps you clearly see how much you’re paying at any given time. Try our amortization calculator to see amortization in action!
Annual Percentage Rate
Not to be confused with interest rate. This mortgage term is for math lovers. Your annual percentage rate (APR) is the total yearly cost of your mortgage expressed as a percentage. APR is great because it gives you a bigger picture of what it costs to finance your loan by accounting for the interest rate and finance charges.
A buydown is a way to lower the interest rate on your mortgage. If you chose to “buy down” your interest rate, you would pay some of the interest upfront in exchange for a lower interest rate—which means a lower mortgage payment over the course of your loan. For example, let’s say you’re on the phone with your Loan Originator and they tell you you’re eligible for an interest rate of 4.25%. You could pay a certain amount upfront to reduce that rate and save money in the long run. (There’s no guarantee you can buy down your interest rate. Check with your Loan Originator and see if you’re eligible for a buydown.)
Not all mortgage terms are good things. To default on your mortgage means to breach any aspect of the note, mortgage, or deed of trust. This could mean you failed to pay your mortgage, didn’t pay taxes or HOA dues, need more insurance, etc. Avoid defaulting at all costs as this can have serious financial consequences and can really hurt your credit. If you do default, talk to your lender and see if there’s a way to create a new loan with better terms that you’re able to commit to. And, as always, make sure you talk to your financial advisor or legal counsel if you find yourself facing potential mortgage default.
Remember when we talked about buydowns? This term is closely related. Discount points (or, basis points) are fees you pay your lender at closing if you buy down the interest rate. One discount point costs 1% of your loan amount. That means, if your mortgage is $175,000, one discount point would cost $1,750. It can be expensive to buy down your interest rate but, if it means a lower payment over the course of your loan, it might be worth it!
Due diligence is the necessary effort a person makes to investigate a property before they decide to buy it. This is very important in real estate transactions because, as the buyer, you want to make sure you know exactly what you’re buying. Due diligence can mean researching the neighborhood and school districts, looking up crime stats, and finding out the history of the home’s immediate area. It might also include asking the current homeowners what it’s been like living there, if they’ve had any plumbing, sewage, or electrical issues, if they’ve experienced any crime, etc. Chances are, there will be some things you discover by simply living in the house you just bought, but taking the time and making the effort to air out as many concerns as possible beforehand will ensure you know what you’re agreeing to purchase!
Eminent domain is the government’s right to take private property within its jurisdiction and repurpose it for public use. When eminent domain is exercised, the government seizing the property is required to pay fair market value (or, just compensation) for it. To illustrate, say you live near a busy highway that just got busier because of a new shopping mall that opened nearby. As such, the state government needs to widen the highway, and because the state deems the road necessary, under eminent domain, they have the right to take your property and pay you the fair market value of it. Unfortunately, you can’t say no to this, but you can, however, argue whether the price the government pays is true fair market value. Not many mortgage terms seem hard to believe but, for some, this one does! If this is you, you might be surprised to learn that eminent domain is in the Fifth and Fourteenth Amendments to the Constitution!
The formal definition of escrow is a financial arrangement where a third party holds and distributes money for two parties involved in a transaction. In some states, escrow is an account for the escrow agent to hold and disburse the loan proceeds. There is another type of escrow that borrowers might be more familiar with: an account your lender will establish for you which will hold the money you pay toward property taxes, homeowners insurance, and mortgage insurance, if applicable. Then, when it comes time to pay those bills, the money you’ve put in your escrow account will be automatically distributed. With an escrow account, you don’t have to worry about getting property tax and homeowners insurance bills in the mail. That money is already included in your monthly mortgage payment so, when the time comes, your loan servicer will distribute the funds appropriately.
In mortgage terms, a lien is the legal right of your lender to secure the payment of debt on your home. It’s a security instrument that says you promised to pay back the money you borrowed to buy this house and if you break that promise, your lender can take you to court or take possession of your house. The lien comes into play when a borrower defaults on their note, mortgage, or deed of trust (remember when we talked about defaulting above?).
A loan estimate is a document that shows a breakdown of the estimated amount of money you have to bring to the closing table. On a loan estimate, you may see numbers like principal, interest, taxes, and insurance, fees associated with your loan, and more. It’s important to review this document carefully and ask your lender and/or real estate agent about any numbers you’re not sure about. Remember that when you sign a loan estimate, you’re agreeing to the numbers you see. Make sure you’re not paying for something you didn’t sign up for!