Common Home Buying Terms Explained

When purchasing a home, buyers must navigate a process that entails a host of terms that may not be familiar to most.

From the initial offer, to the mortgage application process and closing each of the terms helps everyone involved in the transaction communicate in a standard way. As such, it is important that buyers understand the terminology to ensure they are fully informed about every detail of the transaction. Below are a few terms to help buyers get started on their real estate journey.

Mortgage

A mortgage is a legal document used as collateral for a loan. Buyers into an agreement with a lender in which the lender agrees to provide a buyer with the funds to purchase a home. The bank holds the mortgage as collateral until the buyer pays the mortgage in full. Should a borrower stop making payments on the house, the mortgage provides lenders the right to take possession of the property through foreclosure.

Appraisal

The asking price on a house reflects the current market value of the home based on a variety of factors one of which is an appraisal. A home appraisal represents a third party’s professional opinion as to the valuation of the house. Appraisers examine the home’s features such as square footage, number of bedrooms, and presence of a basement. Next, they compare those features to other houses in the area and use data from past sales to determine an appropriate value for the home.

Counteroffer

In a real estate transaction, the initial offer is merely a starting point for negotiations. Sellers may view the initial offer as too low, and in return presents a counteroffer. The counteroffer implies that the seller is willing to accept the buyer’s offer if the buyer agrees to compromise on certain conditions. Examples of such conditions are higher asking price, changing the closing date, modifying the due diligence period, etc. Sellers and buyers go back and forth making counteroffers until each agrees on terms acceptable to both parties.

Earnest Money Deposit

When presenting an offer, buyers also provide a payment that shows their commitment to purchasing the house. The earnest money gives the seller some assurance that the buyer is ready and willing to move forward with the transaction. The real estate brokers place the money in an escrow account and apply the money towards closing costs.

Debt-to-Income (DTI)

As one of the most important loan qualification factors, the Debt-to-Income (DTI) ratio affects how much a lender is willing to loan a borrower. The DTI reflects how much of the borrower’s gross monthly income goes towards debt. Lenders use the DTI to assess the overall financial health of a borrower. The higher the DTI of the borrower, the higher the risk of lending to him or her is for the bank. On the other hand, borrowers with a low DTI pose less of a risk, and those borrowers stand a better chance at receiving favorable lending terms.

Closing Disclosure

Before closing, lenders must provide borrowers with a detailed explanation of all fees involved in the transaction. By law, lenders must provide the closing disclosure at least three days before closing to give borrowers an opportunity to compare it to the original estimate and to ask questions. The disclosure outlines the monthly mortgage payment, which includes principal and interest, home owners insurance, and the amount allocated to escrow. In addition, the disclosure provides details on fees required to close the loan such as recording fees, transfer taxes, prepaid interest and a title insurance policy. Lastly, perhaps the most helpful piece of information on the closing disclosure is the amount the borrower must bring to closing to finalize the transaction.

Escrow

A real estate transaction involves several parties and a great deal of money that must change hands throughout the process. As a means to ensure everyone gets paid the correct amount of money at the appropriate time, the money gets placed into what is known as escrow. Neither the seller nor the buyer has access to the money, instead an impartial third party holds onto the funds. Escrow protects everyone involved in the transaction. Escrow gives each party involved in the transaction the assurance that the money is handled and disbursed appropriately. Borrowers may also hear the term escrow. Escrow represents the reserves lenders keep from the borrower’s mortgage payment to pay the taxes on the property.

PMI (Primary Mortgage Insurance)

Lenders require Primary Mortgage Insurance (PMI) from borrowers who put down less than twenty percent of the home’s value. From the lender’s perspective, borrowers who put down less than twenty percent do not have much invested in the home, and therefore represent a financial risk to the lender. PMI allows the lender to protect their investment in the house should they need to foreclose on the property. With PMI, the lender doesn’t take as big a financial hit because the insurance covers a portion of the loss. Usually a percentage of the loan amount, the PMI is added to the monthly mortgage amount until the borrower accumulates enough equity in the home to lower their risk to the bank.

PITI (Principal, Interest, Taxes and Insurance)

The monthly mortgage payment consists of several components known as Principal, Interest, Taxes and Insurance (PITI). The principal represents the base payment based on the borrower’s loan amount. The lender adds to that interest, which reflects the cost the lender charges to purchase the home. Additionally, they add in taxes to cover property taxes. Lastly, lenders include an amount for insurance to cover homeowners insurance. The result represents the borrower must pay each month. Lenders also use PITI during the loan application to determine a borrower’s ability to afford a mortgage. When applying for a loan, borrowers must prove that their gross monthly income supports the estimated PITI.

Points

Lenders give borrowers a chance to reduce the interest rate on their loan by charging what is known as points. Each point represents one percent of the cost of the loan. The borrower may pay zero, one, or several points to get a cheaper interest rate. Lenders may also charge what are known as origination points, which are a way to pay costs for processing the loan such as notary fees and inspection fees.

Although the terminology may seem confusing at first, getting a handle on each of the terms involved in a real estate transaction helps the buyer remain informed about the process.

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