If you think mortgage terminology is confusing, you’re certainly not alone. The mortgage process is full of jargon that most people won’t encounter outside of purchasing or refinancing a home. With a handful of terms that have similar meanings or sound alike, it’s easy to get lost.
We’re here to help clear some things up. Here is some commonly confused mortgage terminology that you should know if you’re thinking about purchasing or refinancing a home:
What’s the difference between interest rate and APR?
If APR stands for “annual percentage rate,” it should be pretty similar to interest rate, right? Sort of. They’re similar, but the differences are important to understand.
Your interest rate is the cost of borrowing your principal loan amount before any fees are taken into account. Basically, when you borrow money, the lender charges you a percentage of that loan, which you must pay back in addition to the money you borrow. The amount of interest you pay depends on a number of factors, including the type of loan you’re applying for, the length of the loan, your credit score, and the benchmark rates set by the Federal Reserve.
Similar, yet different—APR encompasses the interest rate plus fees like mortgage insurance, closing costs, and loan origination fees. In other words, APR gives you a much clearer picture of what you’ll actually pay for a loan—principal, interest, and any other lender and third party fees. The Truth in Lending Act requires that all consumer loan agreements disclose their APRs to make it easier to compare lenders and home loans.
Even if you only pay some fees once, they’re still included in the APR, since it’s meant to show a broader measurement of the loan’s total cost. That’s why you shouldn’t be surprised if the APR is only a fraction of a percent higher than the interest rate. A few tenths of a percent may not seem like much, but that can add up to tens of thousands of dollars over the life of a loan. Keep in mind that the exact fees that a lender includes in the APR can vary. Make sure to ask what’s included in the APR so you can better compare between lenders.
Lenders are required to disclose both the interest rate and APR before you lock your rate. However, keep in mind that it’s your APR that provides the best estimate of what your mortgage will cost when all is said and done whereas the interest rate is only the cost to borrow the principal amount .
What’s the difference between a good faith estimate and a loan estimate?
If it’s been a few years since applying for your last mortgage (or if your parents are giving you pointers), then you may be familiar with the term “good faith estimate.” Lenders used to provide these forms so borrowers could compare different loans from different lenders. However, as of October 2015, good faith estimates were replaced by loan estimate forms, thanks to the Truth in Lending Act, essentially making the Loan Estimate an evolution of the preceding good faith estimate.
Before the Truth in Lending Act, lenders could use whatever language they wanted to describe the components of their loans, which made comparing mortgage options and fees confusing for borrowers. Now, lenders are required to use a universal, reader-friendly format that lays out the elements of a loan, including APR, predicted monthly payments, and closing costs. Loan estimates are not approval letters or contracts that bind you to a particular lender; they are simply a tool to compare your mortgage options and get an understanding of your mortgage’s associated fees. Lenders must provide you with a Loan Estimate within 3 days of your loan application.
What’s the difference between title insurance and private mortgage insurance (PMI)?
When buying a home or getting a mortgage, you’re likely to come across several kinds of insurance. Two types of insurance that often get confused are title insurance and PMI.
To first explain title insurance, let's start with "title," which refers to the legal concept of who owns the home. It may seem like closing is the last step before the home officially becomes yours, but that is not always the case. In fact, someone else could make a claim to your property well after you've moved in—such as a contractor who performed work on the home years earlier and was never paid. This is what's known as a title defect, and it's why lenders require you to purchase title insurance before you close on your home. Title insurance protects your claim of ownership to the property.
On the other hand, PMI is a kind of insurance that is only required if you're unable to afford a 20% down payment on your home. In this instance, your lender is looking to offset the risk of lending money while still providing affordable loans to borrowers who don’t have the cash or resources to make a large down payment. PMI premiums vary depending on the size of your down payment but typically range from 0.25% to 2% of your annual loan balance. The good news? Unless you have an FHA loan, you only need to have PMI until you've built 20% equity in your home.
Getting a mortgage can be complicated and understanding mortgage terminology might seem intimidating, but it’s the best way to ensure that you’re getting the right loan for your needs—and the best deal. Use our resources to get more insights and information on how to choose a mortgage. When you’re ready to get started, we can get you pre-approved in as little as 3 minutes.