By Cannon Christian
Purchasing a home is a life-changing investment, but the California Association of Realtors found that 43 percent of first-time homebuyers do not completely understand the home buying process. A big decision like buying a first home, combined with confusion about the process, can lead to a detrimental financial mistake.
In honor of April being Financial Literacy Month, here is a glossary of 12 commonly misunderstood terms to guide first-time buyers through the buying and negotiation process.
Underwriting: The underwriting process is used by lenders to determine the amount of risk a mortgage would be. Before approving a loan, an underwriter will evaluate your credit score and history, credit score of a spouse or partner in the purchase, bank accounts, employment history, current income, and current and projected debts and assets.
Points: A point is equal to one percent of the amount borrowed, or principal, of your mortgage. Lenders charge points in both fixed-rate and adjustable-rate mortgages in order to increase the returns to the lender on the mortgage and to cover loan closing costs. These points usually are collected at closing and may be paid by the borrower or the home seller, or may be split between them. There are two types:
- Discount Points are paid to reduce the interest rate on a loan and are normally paid at closing. These fees are tax deductible.
- Origination Points are paid at closing. On a conventional loan, a loan that is not insured or guaranteed by the government, the loan origination fee is the number of points a borrower pays. The loan origination fee is not tax deductible.
Assumable mortgage: A home mortgage that allows the buyer to take over the seller’s mortgage. The buyer makes mortgage payments and complies with other terms of the original seller’s existing loan.
Balloon mortgage:A mortgage that is not fully paid off over the term of the loan, leaving a balance at the end. The borrower must either pay off the remaining mortgage or refinance the loan.
PITI: Abbreviation for the major expenses that make up a mortgage payment: principal, interest, property taxes and homeowners’ insurance.
Prepayment penalty: A charge imposed on a borrower who pays off a mortgage loan before its due date. Lenders impose prepayment penalties to encourage borrowers to hold a debt, and keep paying interest on it for the whole term of the mortgage.
Title report: The written examination of a real estate title search, including a property description, names of titleholders and how the title is held (joint tenancy, for example), tax rate, mortgages and other charges, and real estate taxes due. A title report is needed before a lender will agree to finance the purchase of the property. The report is prepared by a title company, an abstracter, an attorney, or an escrow company, depending on state practice.
Escrow: After a seller accepts the buyer’s offer, the buyer’s funds are held in an escrow account by a third party until the transaction closes. The funds in this account can include funds used to pay home insurance and property taxes.
Contingency: A provision in a contract stating which terms of the contract will be altered or voided if a specific event occurs before the closing of the property. For example, a contingency in your home purchase contract might state that, if the buyer does not approve the inspection report of the physical condition of the property, the buyer does not have to complete the purchase. Or the seller might include a contingency asking for proof that the buyer is financially able to close the deal or for closing to be held off until the seller successfully finds another house to buy.
Private mortgage insurance: Insurance that reimburses a mortgage lender if the buyer (borrower) defaults on the loan and the foreclosure sale price is less than the amount owed to the lender (the mortgage plus the costs of the sale). A home buyer who makes less than a 20 percent down payment will most likely have to purchase private mortgage insurance, commonly referred to as PMI.
Closing costs: Closing costs are fees, charged by lenders and third parties, related to the purchase of the home. An estimated two to five percent of the purchase price of the home. You will usually pay closing costs at the time you close on a mortgage. The cost can include a loan origination fee and processing fee, discount points, underwriting fee, appraisal fee, credit report, title insurance and title search fees.
Earnest money:This is in the form of a deposit and tells the seller that you’re committed and ensures you are not making offers on other for-sale properties. Once the seller accepts your offer, the earnest money deposit will go towards a down payment and closing costs.
Take this glossary with you to your next agent or loan officer meeting and you will feel much more comfortable throughout the home buying process.
Cannon Christian is president of Renovation Realty and a licensed real estate broker.