Mortgage basics
Learn the language of home loans.
A mortgage comes with its own vocabulary. This page explains the main ideas in plain English, from pre-qualification to what goes into your monthly payment. Read it start to finish or go straight to the part you need. It also has a glossary and answers to common questions.
Pre-qualification versus pre-approval
Both give you an early read on what you may be able to borrow. The difference is how much has been checked. Neither one is a final loan approval.
Pre-qualification
A pre-qualification is an early estimate based on what you tell a loan officer about your income, debts and assets. Little or nothing has been verified yet. It is a useful starting point, and it is not a commitment to lend.
Pre-approval
A pre-approval goes further. You complete an application, your credit is checked with your permission, and your income and asset documents are reviewed. It still depends on the property, the appraisal and the lender's final review.
Why the letter matters
When you make an offer, sellers often want to see a letter from a lender. It shows that you have started the financing process. A pre-approval letter usually carries more weight because more has been checked.
The words vary by lender
Lenders do not all use these terms in the same way. When you receive a letter, ask what was reviewed, whether your credit was checked and how long the letter is good for.
What lenders look at
Most loan decisions rest on four things: your credit, your income and debts, your assets and the property. Each loan program weighs them in its own way.
Credit
Your credit reports and scores show how you have handled debt, including whether you paid on time and how much of your available credit you use. Each loan program sets its own credit standards, and lenders can add their own.
Income and debts
Lenders look at how much you earn and how it can be documented. They also compare your monthly debt payments with your monthly income. This comparison is called your debt-to-income ratio, and each program sets its own limit.
Assets
Assets are the funds you have for your down payment, closing costs and reserves, which is money left over after closing. Lenders review your statements to see where the money came from, so expect questions about large deposits.
The property
The home is the security for the loan, so it is reviewed too. An appraisal estimates its value. The type of property and how you plan to use it also matter. Condos, second homes and rentals can come with extra review or different requirements.
Down payment and closing costs
These are the two main sums you bring to a purchase. They are separate, and it helps to plan for both from the start.
Down payment
The down payment is the part of the price you pay yourself. The loan covers the rest. How much you need depends on the loan program, the property and your situation. A larger down payment means a smaller loan.
Closing costs
Closing costs are the fees and charges paid to complete the loan and transfer the home. They commonly include lender charges, the appraisal, title insurance and closing services, and government recording charges and taxes.
Prepaid items
At closing you also pay some costs ahead of time. These usually include homeowners insurance, property taxes and interest for the rest of the month. If your loan has an escrow account, which holds money for taxes and insurance, a starting deposit goes into it.
Where the money can come from
You can use your own funds. Many programs also allow gift funds from family. Some buyers receive a credit from the seller toward closing costs, or help from a down payment assistance program. Each loan type has rules on what is allowed.
Fixed and adjustable rates
Every mortgage has an interest rate, which is what the lender charges you to borrow the money. The rate either stays the same for the whole loan or can change over time.
Fixed-rate loans
With a fixed-rate loan, the interest rate stays the same for the life of the loan, so your principal and interest payment does not change. Your total payment can still change if your property taxes or insurance change.
Adjustable-rate loans
With an adjustable-rate loan, often called an ARM, the rate is usually fixed for an opening period. After that it can go up or down at set times, based on a published market rate called an index. The loan documents set limits, called caps, on how much it can change.
Weighing the two
A fixed rate gives you a principal and interest payment that stays the same. An adjustable rate means your payment can rise or fall after the opening period. Think about how long you expect to keep the loan and how a higher payment would fit your budget.
Rate locks
A rate lock is an agreement that holds your interest rate for a set period while your loan is completed. If the lock runs out before closing, or the details of your loan change, the rate can change. Ask how locks work on your loan.
Mortgage insurance
Mortgage insurance protects the lender, not you, if a loan is not repaid. It is one reason lenders can offer loans with smaller down payments. How it works depends on the type of loan.
Conventional loans and PMI
With a smaller down payment on a conventional loan, you usually pay private mortgage insurance, known as PMI. It is typically part of your monthly payment. PMI can usually be removed later, once you have built enough equity, subject to the loan's requirements.
FHA loans
FHA loans carry their own mortgage insurance, paid both upfront and monthly. It works differently from PMI. In many cases the monthly part stays for the life of the loan.
VA loans
VA loans have no monthly mortgage insurance. A one-time VA funding fee applies to most VA loans and can usually be financed. Some borrowers are exempt from the fee.
Not the same as homeowners insurance
Homeowners insurance covers damage to your home and belongings. Mortgage insurance covers the lender. The two are separate, and a loan can require both.
Your monthly payment
A mortgage payment is usually made up of several parts. Knowing them helps explain why your total payment can change over time, even when your interest rate is fixed.
Principal and interest
Principal is the amount you borrowed. Interest is what the lender charges for lending it. In the early years of most loans, more of each payment goes to interest. Over time, more goes to principal.
Taxes and insurance
Property taxes are charged by local government, and homeowners insurance protects the home. Both can change from year to year. Depending on where the home is, flood insurance may also be required. If your loan has mortgage insurance, it is usually part of the payment as well. In Florida, insurance cost depends on things like the home's age, roof and location. A home's taxable value is usually reset after a sale, so do not budget from the seller's tax bill.
Escrow
With an escrow account, part of each monthly payment is set aside. Your loan servicer, the company that collects your payments, uses it to pay your tax and insurance bills when they are due. The account is reviewed each year, and your payment can go up or down if those bills change.
Association dues
If the home is in a condominium or a homeowners association, you also pay dues. They are usually paid straight to the association and not through your mortgage payment, but lenders count them as part of your monthly housing cost.
Glossary
Words you will hear
- Adjustable-rate mortgage (ARM)
- A loan whose interest rate can change over time. The rate is usually fixed for an opening period, then adjusts at set times based on a published market rate called an index, within limits written into the loan.
- Annual percentage rate (APR)
- A yearly measure of a loan's cost that includes the interest rate and certain fees, so you can compare loans with different rates and fees.
- Appraisal
- A written opinion of a home's value from a licensed or certified appraiser. The lender orders it to check that the home supports the loan amount.
- Closing costs
- The fees and charges paid to complete a loan and transfer a home, such as lender charges, the appraisal, title insurance and government recording charges. They are separate from your down payment.
- Closing Disclosure
- A standard form you receive at least three business days before closing on most home loans. It lists your final loan terms, monthly payment and closing costs. Compare it with your Loan Estimate and ask about any differences.
- Conforming loan
- A conventional loan that meets the guidelines and loan size limits used by Fannie Mae and Freddie Mac. Larger loans are often called jumbo loans and follow separate guidelines.
- Debt-to-income ratio (DTI)
- Your monthly debt payments, including the new housing payment, compared with your monthly income before taxes. Lenders use it to judge how a new mortgage payment fits with what you already owe. Each loan program sets its own limit.
- Down payment
- The part of the purchase price you pay yourself at closing. The loan covers the rest. The amount required depends on the loan program, the property and your situation.
- Earnest money
- A deposit you make after a seller accepts your offer, to show you intend to buy. A third party holds it, and it usually counts toward your costs at closing. Your contract says what happens to it if the sale does not close.
- Equity
- The part of your home's value that is yours: what the home is worth minus what you still owe on it. It changes as you pay down the loan and as the home's value moves up or down.
- Escrow
- Money held on your behalf for a set purpose. During a purchase, a third party holds your deposit. After closing, an escrow account with your loan servicer collects money to pay your property taxes and insurance.
- Fixed-rate mortgage
- A loan whose interest rate stays the same for the life of the loan, so the principal and interest payment does not change.
- HOA dues
- Regular fees paid to a homeowners or condominium association for shared costs such as common areas and building upkeep. Lenders count them as part of your monthly housing cost.
- Homeowners insurance
- A policy that covers damage to your home and belongings from events named in the policy, and usually liability too. Lenders generally require it on a home with a mortgage. Flood coverage is a separate policy.
- Loan Estimate
- A standard form sent to you within three business days after you apply for most home loans. It lays out the estimated loan terms, monthly payment and closing costs so you can compare offers.
- Loan-to-value (LTV)
- The loan amount compared with the home's value. On a purchase, lenders use the lower of the price and the appraised value. Lenders use it when setting the interest rate and fees, mortgage insurance and how much you can borrow.
- Mortgage insurance
- Coverage that protects the lender if a loan is not repaid. It is common on loans with smaller down payments, and it works differently on conventional and FHA loans.
- Non-QM loan
- Short for non-qualified mortgage. A home loan that falls outside the federal qualified mortgage standards and the guidelines that conventional and government loans follow. Income, cash flow or assets are still verified. The interest rate and fees are usually higher than on a conventional loan.
- Origination
- The work of setting up a new loan, from taking your application to closing. The charges for this work are listed as origination charges on your Loan Estimate.
- Points
- An optional upfront charge in exchange for a different interest rate. A lender credit works the other way.
- Pre-approval
- A lender's early, conditional statement of what you may be able to borrow, based on an application, a credit check and a review of your documents. It is not a final loan approval.
- Pre-qualification
- An early estimate of what you may be able to borrow, based on information you provide. It is not a commitment to lend.
- Principal
- The amount you borrow, and later the balance you still owe, not counting interest. On most loans, part of each monthly payment goes toward paying it down.
- Rate lock
- An agreement that holds your interest rate for a set period while your loan is completed. If the lock runs out or the details of your loan change, the rate can change.
- Reserves
- Money left in your accounts after you pay your down payment and closing costs. Some loans require you to show enough reserves to cover a set number of monthly payments.
- Title insurance
- Coverage against problems in a property's ownership history, such as an old unpaid debt attached to the home or a recording error. A lender's policy protects the lender. A separate owner's policy protects you.
- Underwriting
- The lender's review of your credit, income, assets and the property to decide whether the loan meets the program's guidelines.
Common questions
Asked almost every day
How much home can I afford?
There are two answers: what a lender may approve and what feels comfortable to you. Lenders compare your monthly debts, including the new housing payment, with your income. You know the rest of your budget, such as utilities, upkeep, travel to work and your other goals. A pre-qualification gives you an early estimate to start from, and it is fine to choose a payment below the most a lender would allow.
What credit score do I need to buy a home?
There is no single number. Each loan program sets its own credit standards, and lenders can add their own on top. Your score is also only one part of the picture, along with your income, debts, down payment and the property. With your permission, your loan officer can review your credit and tell you which programs may fit.
Does applying for a mortgage affect my credit?
A full application includes a credit check called a hard inquiry, which may lower your score slightly for a time. Credit scoring models generally treat several mortgage inquiries made within a short shopping period as one inquiry, so comparing lenders usually has a limited effect. We check your credit only with your permission.
Is the interest rate the only cost of a loan?
No. The interest rate is what you pay to borrow the money. A loan also has closing costs and, on some loans, mortgage insurance. Two loans with the same rate can cost different amounts once those are counted. Your Loan Estimate shows the rate, the fees and the projected payments on one standard form, which makes it possible to compare complete offers and not only rates.
Can I get a mortgage if I am self-employed?
Being self-employed does not rule out a mortgage. It changes how your income is documented. Standard loans usually document self-employed income with tax returns. If business write-offs make the income on your tax returns lower than what your business brings in, some non-QM programs, which document income in other ways, can use bank statements or other records. Those programs typically call for a larger down payment, and the interest rate and fees are usually higher than on a conventional loan. Your loan officer can explain which kind of paperwork fits your situation.
Do I need an escrow account?
Often, yes. An escrow account collects part of each monthly payment and pays your property taxes and homeowners insurance when they are due. Many loans require one, especially with a smaller down payment. Where it is optional, the lender may set conditions for going without it. Your Loan Estimate shows whether an escrow account is part of your loan.
When can mortgage insurance be removed?
It depends on the type of loan. On a conventional loan, private mortgage insurance can usually be removed once you have built enough equity, subject to the loan's requirements. FHA mortgage insurance follows different rules, and in many cases the monthly part stays for the life of the loan. Some homeowners refinance into a different loan to remove it, which has its own costs. Your loan officer, or the company that collects your payments, can tell you what applies to your loan.
How is financing a condo different from a house?
With a condo, the lender reviews the building and its association as well as you and the unit. The review can cover things such as the association's budget and insurance and the condition of the building. This can add documents and steps. Some buildings do not meet the requirements of some loan programs, so tell your loan officer early if you are looking at condos.
Can I pay off my mortgage early?
On most home loans, yes. You can usually pay extra toward principal or pay the loan off ahead of schedule. Some loans carry a prepayment penalty, which is a charge for paying the loan off within a set period. These are more common on investment property loans and on some non-QM loans. Your loan documents state whether your loan has one, so ask before you choose.
What happens to my loan after closing?
You make your monthly payments to a loan servicer, the company that collects payments and manages any escrow account. The servicer may be a different company from the one that made your loan, and servicing can be transferred later. If that happens, you are told in writing where to send your payments. A transfer does not change the terms of your loan.
Information on this page is general and educational. It is not a commitment to lend or an offer of credit. Loan approval, programs and terms depend on a full application and are subject to underwriting. Not all applicants will qualify.
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