A Breakdown of the Financial Buzzwords You Need to Know Before Buying a Home

Home buying, while super exciting, is also super stressful — and all the terms that get casually thrown around don't always make a ton of sense to the average person. Seriously, what is escrow, and what does it mean to be in it?!

So, we partnered with Rocket Mortgage on a study to better understand what women around the country need help with when embarking on their home buying journey. The results that came back showed a wide range of feelings, and clarified the terms and phrases that really need some explaining.

To get an expert take on what you need to know, we turned to Rocket Mortgage Executive Vice President of Purchase Katie Barish to help women get the skinny on all those words real estate agents love to talk about when you're on the hunt for your dream house. We'll get you up to speed in no time.

Credit Score

Simply put, this is a score that represents your ability to pay on your debts. Things that will impact credit score include paying your credit cards or loans on time and how much available credit you are using. You are probably stretching yourself if you are getting near your credit limit each month. How long you have had credit will also play into this score. What is usually not reported here are things like rent payments, utilities, internet, and cell phone bills.

Mortgage

A mortgage is a type of loan that is specific to financing a home. Most home loans are either a fixed-rate or adjustable-rate mortgage. Fixed rate simply means that your interest rate will remain the same for the life of the loan. An adjustable-rate mortgage (ARM) means that the starting interest rate will be fixed for a period of time (often three, five, seven, or 10 years), then it may adjust based on market conditions over the remainder of the term — which is generally 30 years. ARMs usually come with a lower starting interest rate and payment than a fixed-rate mortgage. Homebuyers may choose an ARM if they don't plan to stay in the home for the long term — not long past that initial fixed-rate period. You might choose a fixed rate, on the other hand, if you think you will be in the home longer term and want to lock in that interest rate for up to 30 years.

Closing Costs

There are costs associated with financing a property that the home buyer must pay at closing. Pulling a credit report, getting an appraisal, ordering a flood certification, and more are also included here. Additionally, you may also hear about points, which are the cost of acquiring your interest rate. Lenders have multiple rates to choose from which have different costs associated. They will present options with a rate and points combination that make the most sense for the client's goals. Typically, a buyer can pay more in points up front as part of their closing costs for a lower interest rate over the life of their loan. So, while they may be spending more money up front, they could potentially be saving thousands in the years to come thanks to paying for those points.

Down Payment

When you buy a home, and use a mortgage to do so, there is often an expectation that you put some money down. Known as the down payment, this money is a percent of the purchase price or appraised value of the home — whichever is lower. For example, on a $100,000 purchase price with a 3.5-percent down payment requirement, the homebuyer would need to have $3,500 for the down payment.

Interest Rate

The interest rate is simply the cost of borrowing money. In a mortgage, the interest is usually charged monthly and is included as part of the payment.

Appraisal

The appraisal is a professional's opinion of the value of the home. The appraiser compares the home to recent sales nearby that are similar in size, age, construction, and a few other related variables. This report tells the buyer, seller, and lender what the market value of the home is. This is critical to securing a mortgage because a key part of home financing is the loan-to-value ratio (LTV). For instance, if the appraised value of the home is $100,000 and the buyer has a $5,000 down payment, then they are taking out a $95,000 loan with a 95-percent LTV. Each loan type has a specific LTV requirement. If the appraised value is lower than what the buyer is expecting, they may need to bring more money to closing in order to meet that LTV requirement.

Debt-to-Income (DTI) Ratio

Lenders have rules to follow based on guidelines set by entities like Fannie Mae, Freddie Mac, the Federal Housing Administration, and the Department of Veterans Affairs, around how much debt — credit cards and loans, for example — a homebuyer can have in comparison to their total gross income (before taxes are taken out). To find your DTI, your lender would divide your total monthly debt payments by your monthly income. For example, a lender requires a maximum DTI of 45 percent. Your debt payments each month are $1,000 while your income is $4,000. That means your DTI is 25 percent ($1,000/$4,000), well below the maximum percent allowed.

APR

When you finance a home with a mortgage, there are things like a title closing fee, appraisal, and interest rate points that are part of the cost to finance the home. APR stands for annual percentage rate, and it takes all those extra costs and expresses them as a percentage. To make it easier to compare all the costs from a lender versus the costs to finance with another lender, you can compare the APR for a more apples-to-apples comparison.

Home Inspection

The home inspection is a very important part of the home-buying process. When you purchase a house, there will always be things that need to be fixed and maintained. However, you want to make sure that after you close, you aren't walking into an unforeseen expense. To make sure, you should hire a licensed inspector. They will evaluate all the systems of the house, including quality of insulation in the attic, the crawl space, foundation, electrical, plumbing, roof, and more. This part of the process can feel a little scary, but don't worry! It's the inspector's job to find everything wrong with the home so you can make an informed decision about proceeding with the purchase.

Escrow

When someone buys a house, there are annual property taxes and insurance bills that need to be paid. These can end up being large expenses when presented as a lump sum, but if they are broken up over multiple installments, they become manageable. Because of this, many homebuyers will choose to have these costs built into their monthly mortgage payment. In some cases, this may be a requirement of the loan program used to buy the home. In these situations, the servicer (the business collecting and managing the mortgage payment) will create an escrow account for the client to hold these monthly tax and insurance deposits. At the time the bills are due, the company will pay them out on your behalf. Remember that taxes often increase annually, so even though you may have a fixed-rate loan, your monthly mortgage payment may increase to cover rising taxes.

Earnest Money Deposit

This is the dollar amount put forth to show your commitment to purchasing the home. The earnest money deposit (EMD) varies based on purchase price, as well as the expectations of the local real estate market. Your agent will guide you through this process. The money will end up being credited toward your down payment or closing costs when you close on the home or returned to you if it is not needed for the financing.

Preapproval

Getting preapproved is generally one of the first steps in the home buying process. When you go through this process, a lender will review your stated income, assets, and credit alongside your desired purchase price. They may or may not request to review additional documentation, like pay stubs or bank statements, to strengthen their recommendation. They will also ask to pull and review your credit. This is all very important because it's critical that before you start looking at houses, you have certainty that you will be able to qualify for the financing. It's no fun finding the home of your dreams, getting your hopes up, and then not being able to secure the mortgage.

A preapproval is also the bare minimum of what most real estate agents will want to see before showing homes, and proof of it is often required as part of the process of negotiating the offer. Rocket Mortgage takes this process a step further with a Verified Approval Letter to provide both homebuyers and real estate agents certainty that once they find the home of their dreams, they will qualify.

Lease-Back

Sometimes when you buy a home, the sellers are not ready to move out on the day of closing. If this occurs, you can negotiate the date of occupancy. However, you are responsible for the mortgage payment from the first day you sign the mortgage. If the sellers aren't ready to move out, you can negotiate a lease- or rent-back in the purchase contract, which simply means that they will pay you rent for the days they are occupying the home after you have officially taken ownership.

Ready to start the home buying process? Head to Rocket Mortgage to learn more and apply for a mortgage.

Rocket Mortgage, LLC; NMLS #3030; www.NMLSConsumerAccess.org. Equal Housing Lender. Licensed in 50 states. For additional information please visit RocketMortgage.com.

Illustrations by Stephanie DeAngelis