When I was a kid, I remember building forts in my living room and thinking about how cool it would be when I got to buy my own real home.
I mean, how hard could it be?
Obviously, I've learned there are a few more steps to take in order to buy or refinance a home. It takes more than just gathering blankets and pillows from around the house.
Although there are a few mortgage terms that seem to really get confusing for first-time homebuyers, here's a quick guide to help grasp mortgage lingo:
Mortgage Terms 101 for First Time Homebuyers
Pre-Qualification vs. Pre-Approval
Both of these terms have that fantastic prefix pre-, noting that they will be done before something else, but these two terms are notorious for getting mixed up.
Getting pre-qualified is like taking a brief survey based on some basic financial information, as well as potential down-payment/initial investment information.
Lenders can provide a type of tentative green, yellow, or red light to determine your eligibility for a specific loan.
Pre-qualification gives a strong idea as to how much of a loan can be afforded and how expensive of a house can be purchased.
Here's what really needs to be secured before beginning any home search.
A pre-approval happens when your lender gives the a-okay or the not-gonna-happen for a potential loan based on a completed application, verification of income, assets, employment check, credit history, and other necessary information.
However, once pre-approved, the real home searching fun can begin!
Getting a pre-approval can make the home buying process go much smoother.
Debt to Income (DTI) Ratio
What fun would it be to find and buy a home without adding a few mathematical equations?!
A debt-to-income ratio is one of those basic equations used by your lender to determine whether enough money is made in order to afford the potential loan.
A simple recommendation for personal finance applies to first-time homebuyers trying to secure a home loan:
Earn more money than you spend.
When tracking a new home, I try to always remind my homebuyers that the amount of money they make must validate the amount of money they are asking to borrow.
I always recommend that anyone interested in purchasing a new home needs to have a strong idea of their DTI ratio.
Consider these financial obligations when calculating a personal DTI ratio:
- Car payments
- Credit card payments
- Student/personal loans
- Child support/alimony
- Any other monthly financial obligations
The goal is to have as low of a DTI number as possible. That way, there will be more money available to pay a monthly mortgage.
Fixed vs Arm vs Balloon
Just looking at these three mortgage loan terms together appear ridiculous. There doesn't seem to be any connection between how they could possibly be related.
However, these three terms are the bread and butter of the mortgage industry.
Knowing the differences between the three is a much-needed ingredient to deciding which mortgage is best for each homebuyers' needs.
Here's a quick overview of each:
Fixed Rate Mortgage
- The most popular
- Offered between 10-40 year mortgage options, where the interest rate remains the same for the life of the loan
- Payments are predictable
Adjustable Rate Mortgage
- The rate of interest only remains fixed for a specific period of time (usually 1, 3, or 5 years)
- Interest rate is lower in the beginning; adjusts at set intervals after initial period is over
- Interest rate adjusts to reflect market conditions (can rise or lower)
- Payments are not always predictable
- Cheaper for the first few years
- After initial period of time, the rest of the loan is due in one lump sum, known as the balloon
- Potentially good for buyers who are:
- looking to move after a few years (before needing to make the balloon or lump sum payment)
- commission-based or earners of large bonuses that can put the money towards the final balloon payment
Good Faith Estimate
Plain and simple - an estimate of the potential closing costs that a new homebuyer will pay.
This big, fancy word is just a term to schedule how the loan will get repaid.
This payment schedule includes how much money will go towards the principal and how much will go towards the interest.
Speaking of, here's the difference between these two terms:
The amount of money actually borrowed for the mortgage.
That percentage that the bank gets. Interest is usually the bulk of the monthly payment until it has been reached - it's the money that the bank or lender earns from the home purchase.
A type of sub-account that is set up during closing. The escrow will include money to pay homeowner's insurance and yearly taxes, which will be wrapped into the annual mortgage payment and divided among twelve monthly payments.
If taxes or homeowner's insurance rise, this can affect the annual and monthly payment each year.
Don't get overwhelmed!
Sure, these mortgage terms seem to be a bit confusing and at times intimidating. But, they don't have to be!
Doing a bit of homework before purchasing a new home is one of the best ways that new homebuyers can prepare for their exciting investment.
A quick checklist to remember before beginning the search for the perfect home:
- Try to pay off as much debt as possible so a debt-to-income ratio is not massive.
- Don't get excited about a home that cannot be afforded; don't spend more money than is earned.
- Get pre-approved to make the purchasing process smoother and quicker.
- Get a good idea of a personal DTI ratio.
- Use one of these mortgage calculators to get an idea of which type of mortgage works best for personal purchasing needs.
And my number one recommendation for anyone looking to buy a new home: Don't be afraid to ask for help!
Making the perfect move to the perfect home doesn't have to be overwhelming or confusing!
Looking to move to the Kansas City metro area? Looking to refinance?
Let's work together to buy that dream home!