Understanding home loan basics
Do you know what a mortgage is? There are a lot of moving parts when it comes to getting a Rhode Island home loan, but do you really know what each term means and how it impacts you as a homebuyer? Understanding the basic terms in advance can make the process less stressful and help you feel more at ease.
What are the essential components of a home loan?
1. Mortgage
A mortgage is a legal agreement between a borrower and a lender that provides the borrower with the funds needed to purchase or refinance a home. If the borrower doesn’t repay the loan in accordance with the agreement’s terms, the lender has the right to take the property.
2. Principal
The principal is the amount you borrow from a lender to pay for a home before any interest is added. It is the total financed amount on which interest begins to accumulate.
3. Interest
In a mortgage loan, interest is the amount you must pay in addition to the principal amount borrowed. It’s typically represented as a percentage rate based on the total balance remaining on the loan.
4. Annual Percentage Rate (APR)
Think of this as the total cost of your mortgage. It’s the interest rate plus any additional fees you’ll pay annually. Your APR will usually be higher than your regular interest rate because it factors in costs like broker fees, points paid, closing costs, and other fees. It’s possible for different lenders to offer you the same interest rate but have a different APR due to different fee amounts. Keep that in mind!
5. Points
Mortgage points are fees you pay your mortgage lender to reduce the interest rate of your loan. The cost of one point is equal to 1% of your total loan amount, and there are two kinds: origination points and discount points. Origination points are paid to the lender to process your loan. Discount points are paid upfront to reduce the interest rate of your loan.
6. Loan Amortization
Amortization is the process of paying off a loan in regular installments over a period of time. You will receive an amortization schedule that shows how much of each monthly payment goes toward the principal and how much goes toward interest on your loan.
7. Private Mortgage Insurance
If your down payment for a conventional loan is less than 20% of the home purchase price, you may be required to get private mortgage insurance (PMI). PMI protects the entity lending the money — if you stop paying your mortgage payments. You typically pay for PMI monthly alongside your usual mortgage payment. Once you reach 20% equity, you should ask if you can cancel PMI, which can reduce your monthly mortgage payment. Government loans, like those issued by the FHA, require mortgage insurance (MI), which is like PMI, except you typically do not have the option to cancel once you reach 20% equity.
8. Equity
Your equity is the dollar amount of the value of the home that you currently own, free from any liens. Equity is calculated as the difference between your home’s current market value and the outstanding balance of your mortgage loan and any other monetary liens against the property.
9. Appraised value
Appraised home value – All amounts owed on the property = Home Equity
10. Closing Costs
Closing costs are the various fees required to close a real estate transaction. All mortgages have costs associated with closing. Closing costs are fees that the borrower must pay to third-party vendors who provide the services needed to get the loan cleared to close. To make it easier for the borrower, these fees are typically collected by the lender and paid to the vendors by the settlement agent, but not always, some fees may be paid directly to the service provider. Closing costs typically run between 3-7 % of the loan amount. Some of the items included as closing costs* are listed below:
- Appraisal
- Lenders Title Insurance
- Property Survey
- Tax Survey
- Credit Report
- Flood Certificate
- Municipal Lien Certificate
- Settlements Agent Fee
- Underwriting Fee
- Mortgage Recording Fee
- Property Survey
- Tax Survey
*Note these can vary by state.
What is your lender’s role when you get a mortgage?
Your loan officer will explain the loan options available to you, review your credit and income information, and help determine if you are qualified for a loan and, if so, for how much.
Mastering the fundamentals of home loans is a wonderful first step in the process. With these terms at your fingertips, you can focus on what really matters- submitting a complete mortgage application, comparing loan options, and finding your new Rhode Island home with one of our experienced loan officers!
