The process of purchasing a home involves many steps. From finding the home to writing the offer to securing the loan and moving in, each step comes with it’s own set of challenges. One of those challenges is understanding the lingo from mortgage lenders. They tend to speak quickly and if someone is not used to the terms they are throwing around, they can find themselves feeling frustrated or embarrassed to ask questions.
Before agree to any contract or terms from a mortgage lender or mortgage broker be sure to understand all terms being discussed. Here is a look at some commonly used terms, their definitions and how they might be used during the home buying process.
A variable rate refers to a rate that can change along the way. These rates are usually based on monetary indexes around the world. For instance, one of the more common indexes is the LIBOR. A variable rate loan may be written to be 3 percentage points above the LIBOR interest rate. So if the LIBOR interest rate is 2 percent, then the variable rate loan would be five percent.
The danger to this type of loan is that as the base rate increases so to does the interest rate on the mortgage. However the advantage to a variable rate loan is that if money is cheap to borrow and the borrower has a short term time horizon, they can save quite a bit of money without absorbing too much risk.
Another common term mortgage lenders use is something called a rate cap, or they may say “the rate is capped at…” this is the number at which the interest rate can no longer be raised on a variable rate loan. So if the base rate on a variable interest loan rises the rate cap may say that the interest rate can not be raised more than 2 percentage points per year with a cap of 8 percent. The rate cap is a protection built in for the buyer so that the payments do not become astronomical and have a finite high point.
Interest Only Loan
An interest only loan is a mortgage product by which the borrower is merely paying the interest on the note every month. This means they are never paying down any principal. The advantage to this type of loan is that if the real estate market is rising, the property will gain equity over time. This will allow the borrower to make smaller payments to the mortgage company and “buy more house.” The downside risk is that in a flat or down real estate market, the buyer is not building any equity. This means when they go to sell their property, they will have need to saved cash to pay the real estate agents as well as place a downpayment on a new home.
Points or Buying Down Points
Mortgage lenders often offer several different kinds of loans to a client when trying to secure a loan. Some of those packages might include something called points. A point is one percent of the total loan amount. A borrower may buy points to get a cheaper interest rate over the life of the loan. The mortgage lenders get the benefit of more money in their pocket at the time of the loan, while the buyer gains the advantage of smaller monthly payments because of a better interest rate. Points are usually available to buy in halves or quarters starting at a half point and going to about two points depending on current market conditions.