Mortgage Glossary

Clear, jargon-free definitions of the mortgage terms you will encounter during the home buying process.

A

Amortization

Amortization is the process of paying off a mortgage through regular monthly payments over a set period of time. Each payment is split between principal, which reduces the loan balance, and interest, which is the cost of borrowing. In the early years of a mortgage, a larger portion of each payment goes toward interest, with the balance gradually shifting toward principal over time. A 30-year amortization schedule, for example, spreads repayment across 360 monthly payments.

Appraisal

An appraisal is a professional assessment of a property's market value, conducted by a licensed appraiser. Lenders require an appraisal before approving a mortgage to ensure the home is worth at least as much as the loan amount. The appraiser evaluates the property's condition, features, and location, and compares it to recent sales of similar homes in the area. The buyer typically pays for the appraisal, which usually costs between $300 and $600.

C

Closing Costs

Closing costs are the fees and expenses paid at the time a mortgage transaction is finalized. They typically range from 2 to 5 percent of the loan amount and include charges such as the appraisal fee, title insurance, origination fees, attorney fees, and prepaid items like homeowners insurance and property taxes. Closing costs can sometimes be negotiated with the seller or rolled into the loan amount.

D

Debt-to-Income Ratio (DTI)

Your debt-to-income ratio is the percentage of your gross monthly income that goes toward paying debts, including your mortgage, car loans, student loans, and credit card minimums. Lenders use DTI to evaluate your ability to manage monthly payments. Most mortgage programs prefer a DTI of 43 percent or lower, though some programs allow up to 50 percent with compensating factors. A lower DTI improves your chances of approval and may qualify you for better rates.

Down Payment

The down payment is the upfront cash you pay toward the purchase price of a home, with the remainder covered by your mortgage. Down payment requirements vary by loan type: conventional loans may require as little as 3 percent, FHA loans require 3.5 percent, and VA and USDA loans offer zero down payment options. Putting at least 20 percent down on a conventional loan allows you to avoid private mortgage insurance. A larger down payment also reduces your loan amount, resulting in lower monthly payments.

E

Earnest Money

Earnest money is a deposit made by the buyer when submitting an offer on a home to demonstrate serious intent to purchase. It is typically 1 to 3 percent of the purchase price and is held in an escrow account until closing. If the sale goes through, the earnest money is applied toward your down payment or closing costs. If the deal falls through for a reason covered by your contract contingencies, you can usually get the deposit refunded.

Equity

Home equity is the difference between your home's current market value and the amount you still owe on your mortgage. As you make payments and your home appreciates in value, your equity grows. Equity can be accessed through a cash-out refinance or home equity loan, and it serves as a key measure of your financial stake in the property. Building equity is one of the primary wealth-building benefits of homeownership.

Escrow

Escrow refers to a neutral third-party account used during the home buying process and throughout the life of your mortgage. During the purchase, an escrow company holds funds such as earnest money until all conditions of the sale are met. After closing, your lender may maintain an escrow account to collect and pay your property taxes and homeowners insurance on your behalf as part of your monthly mortgage payment.

F

Fixed-Rate Mortgage

A fixed-rate mortgage is a home loan with an interest rate that remains the same for the entire term of the loan. This means your monthly principal and interest payment stays constant, providing predictability and protection against rising interest rates. Fixed-rate mortgages are available in various terms, with 15-year and 30-year being the most common. They are the most popular mortgage type in the United States because of the payment stability they offer.

I

Interest Rate

The interest rate is the cost of borrowing money for your mortgage, expressed as a percentage of the loan amount charged annually. Your rate is determined by factors including your credit score, down payment, loan type, loan term, and current market conditions. Even a small difference in rate can significantly impact total cost over the life of the loan. For example, a 0.5 percent reduction on a $400,000 mortgage can save over $40,000 in interest over 30 years.

L

Loan-to-Value Ratio (LTV)

Loan-to-value ratio is the amount of your mortgage divided by the appraised value of the property, expressed as a percentage. For example, if you borrow $320,000 on a home appraised at $400,000, your LTV is 80 percent. LTV is a key factor in mortgage approval and pricing. A lower LTV typically means better rates and the ability to avoid mortgage insurance, while a higher LTV indicates more risk for the lender.

P

Pre-Approval

Mortgage pre-approval is a formal evaluation by a lender that determines how much you can borrow based on your income, assets, credit, and debts. It involves a credit check and document review and results in a pre-approval letter that shows sellers you are a serious, qualified buyer. Pre-approval is more thorough than pre-qualification and carries more weight in competitive markets. A pre-approval letter is typically valid for 60 to 90 days.

Pre-Qualification

Pre-qualification is an initial estimate of how much you may be able to borrow, based on self-reported financial information. It does not involve a credit check or document verification, so it is less thorough than a pre-approval. Pre-qualification gives you a general idea of your budget and is a useful first step before house hunting. However, it does not carry the same weight as a pre-approval letter when making offers on homes.

Principal

Principal is the original amount of money you borrow for your mortgage, not including interest. Each monthly payment reduces your principal balance, which in turn reduces the amount of interest charged in the following month. As you pay down the principal over time, you build equity in your home. On a $400,000 mortgage, the entire $400,000 is the principal, and the total amount you repay over the life of the loan will be the principal plus all accumulated interest.

Private Mortgage Insurance (PMI)

Private mortgage insurance is a monthly premium required on conventional loans when the borrower puts less than 20 percent down. PMI protects the lender, not the borrower, in case of default. The cost typically ranges from 0.5 to 1.5 percent of the loan amount annually, added to your monthly payment. PMI can be removed once you reach 20 percent equity in your home, either through payments or appreciation, by contacting your lender to request cancellation.

R

Refinance

Refinancing is the process of replacing your existing mortgage with a new one, typically to obtain a lower interest rate, change your loan term, or access home equity. A rate-and-term refinance adjusts your rate or repayment period, while a cash-out refinance lets you borrow against your equity and receive the difference in cash. Refinancing involves closing costs similar to your original mortgage, so it is important to calculate your break-even point to determine if it makes financial sense.

T

Title Insurance

Title insurance is a policy that protects the buyer and lender against claims or disputes over property ownership. Before closing, a title company searches public records to verify the seller has clear legal ownership and that there are no liens, encumbrances, or other issues that could affect the transfer. If a problem arises after closing, title insurance covers the legal costs and potential losses. There are two types: lender's title insurance, which is required, and owner's title insurance, which is optional but recommended.

U

Underwriting

Underwriting is the process by which a lender evaluates your financial profile to determine whether to approve your mortgage application. The underwriter reviews your credit history, income, assets, debts, and the property appraisal to assess the overall risk of the loan. This step typically takes several days to a couple of weeks. The underwriter may request additional documentation or clarification before issuing a final decision, which will be approved, conditionally approved, suspended, or denied.

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