For most twenty-somethings, buying a home is the first step towards actual adulthood. It’s also one of the most confusing. As you try to make heads or tails of your mortgage term you’ll come across a mind numbing tidal wave of acronyms. Do you have an ARM or an FRM? Did you pay 20 percent down or do you have to pay for PMI? And how’s your DTI?
To save you from completely losing your mind, here are a few key mortgage and home buying terms you should know going into the process.
ARM: Adjustable-rate mortgage
Also known as a variable rate mortgage or a tracker mortgage, an ARM is a mortgage loan offered with the understanding that the lender will adjust the rate annually, based on whichever index the mortgage loan is tied to.
When you first sign up for an ARM, you will be given a “teaser rate,” which will be significantly lower than fixed mortgage rates. The risk comes in as the years pass – borrowers win when rates go down but lose when rates go up.
FRM: Fixed-rate mortgage
For the risk averse, there’s always a fixed-rate mortgage. Unlike an ARM, you’ll always make the same monthly payment on an FRM and the interest rate will remain unchanged. The upside to fixed mortgages is there are no big surprises at the end of the year, but you might end up kicking yourself down the road if ARM rates stay low.
DTI: Debt-To-Income Ratio
Your debt-to-income ratio is the percentage of your income that goes to paying debt. When buying a home there are two figures to consider – your front-end DTI ratio and your back-end DTI ratio. Your front-end ratio covers the percentage of your income that would go towards all of your housing costs, while your back-end ratio covers your housing costs plus other debts, like credit cards, car notes and student loans. Lenders prefer borrowers have a front-end ratio under 28 percent and a back-end ratio under 36 percent.
PITI: Principal, Interest, Tax and Insurance
Your mortgage payment will consist of four factors – the loan principal, accrued interest, local taxes and homeowner’s insurance. Principal contributes to your equity while interest covers the cost of borrowing. Taxes are determined by state and local government based on the value of your property and local tax rates. Homeowner’s insurance covers a home and its contents from loss and accidents.
PMI: Private mortgage insurance
If your down payment on your home is less than 20 percent of the cost of your home, lenders may require you to sign up for private mortgage insurance. The insurance covers lenders in the case of borrower default. The bad news is that PMI can cost borrowers hundreds of extra dollars a month, but the good news is, once you own up to 20 percent equity in your home, the lender is required, by law, to cancel the insurance.
HAMP: Home Affordable Modification Program & HARP: Home Affordable Refinance Program
HAMP and HARP are part of the government’s Making Home Affordable program. Under HAMP, borrowers who are struggling financially can modify their loan to make their monthly payments more affordable. HARP allows borrowers to refinance their homes at a lower interest rate, even if their mortgage is “underwater.” The term underwater refers to the situation when a borrower owes more on their home loan than their property is currently worth. Millions of homes fell “underwater” after the 2008 housing market crash, which largely contributed to the creation of the HAMP and HARP programs.
Arit John is a reporter at loans.org, a website dedicated to helping consumers sift through the ambiguous details of the financial industry. Loans.org aims to educate the public by providing free access to relevant and unbiased financial information in addition to allowing visitors to apply for loans through the use of free online applications. She can be reached via email at firstname.lastname@example.org.
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