Buying and/or selling real estate can be pretty intimidating to most of us. One of the main reasons for this is all the confusing real estate jargon and legal and financial terms involved. So understanding these terms can provide both buyers and sellers some peace of mind. It may even save you not a little money during the process. With that in mind, we offer this treatment of 6 financing terms you need to know when buying and selling real estate in .
1. Adjustable-Rate and Fixed-Rate Mortgages
Actually, this first one is a two-for. We’re examining two mortgage-related financing terms in one go because buyers and sellers typically encounter, at some point, both of them in the buying/selling process.
An adjustable-rate mortgage is, as the name suggests, a mortgage in which the rate changes over time, is adjustable. “This type of mortgage usually has a lower initial rate (for a set number of years), then the rate may go up or down, depending on the specified index rate used for determination. Usually preferred for short-term ownership, the repayment period for ARMs are typically 5,7, or 10 years, but they can be issued for longer time periods.”
A fixed-rate mortgage, on the other hand, has a rate that does not change, is fixed. This is a “conventional loan with a pre-determined (or ‘locked in’) interest rate for the duration of the loan repayment period. They are traditionally 30 years in length, but can be issued for 15 years, 10years, or another duration.”
Typically, people choose an adjustable-rate mortgage when they plan to sell or refinance the real estate before the introductory period ends. A fixed-rate mortgage makes more financial sense if you plan to hold onto the real estate for more than five years because there’s less risk involved.
2. Pre-Approval Letter
This is an important one of our financing terms for both buyers and sellers, those on either end of the transaction. Buyers are always urged to have their pre-approval letter in hand when house hunting and sellers are commonly advised to ensure the potential buyers do in fact have a pre-approval letter.
A pre-approval letter is, basically, an estimate from a lender of how much they will actually lend a buyer. It helps buyers determine what they can actually afford and lets sellers know that buyers are serious and can most likely get the needed financing.
A lender will issue you a pre-approval letter after carefully reviewing all your financial information – credit score, payment history, employment history and income, debt-to-income ratio, and so on. Then after determining how much you can borrow, the lender will lock in your loan at a specific rate. Pre-approval carries much more weight than pre-qualification and is almost as good as actually getting the mortgage loan itself.
3. FHA Loans
One of the financing terms that often generates some confusion among those buying and selling real estate in is “FHA loans.” Let’s dig a little deeper, then, into these federally backed housing loans.
FHA loans are “[l]oans insured by the Federal Housing Administration (FHA). With attractive financing rates and less stringent lending requirements than conventional mortgages, FHA loans are often appealing options for buyers with lower credit scores and/or smaller down payments. They do, however, require two types of mortgage insurance: an upfront premium and an annual premium, which is wrapped into monthly mortgage payments.”
4. Private Mortgage Insurance (PMI)
This, then, brings us to private mortgage insurance (PMI) as one of our important financing terms. This is typically a monthly insurance payment buyers have to pay when they make a down payment of less than 20% of the purchase price. The purpose of PMI is to protect lenders against borrower default.
“PMI is insurance for the mortgage lender’s benefit, not yours. You pay a monthly premium to the insurer, and the coverage will pay a portion of the balance due to the mortgage lender in the event you default on the home loan. The insurance does not prevent you from facing foreclosure or experiencing a decrease in your credit score if you get behind on mortgage payments. The lender requires PMI because it is assuming additional risk by accepting a lower amount of upfront money toward the purchase.”
You can, of course, avoid having to pay for PMI by paying at least 20%down. And be aware that PMI works a little differently for FHA loans than it does for conventional loans.
This is another of the financing terms that frequently involves some misunderstanding. The name doesn’t really explain much, but basically, it’s just prepaid interest on a mortgage loan.
When it comes to points as prepaid interest, a point is “equal to one percent of the loan amount. The advantage of paying points upfront is that a lower interest rate can be secured for the lifetime of the loan. This may be a good deal if a buyer plans to stay in the home for many years (so the long-term interest savings outweigh the initial cost in points).”
6. Earnest Money
Another of the financing terms impacting both buyers and sellers, the earnest money is also known as a good-faith deposit. Typically held by a neutral third party, this earnest money demonstrates to a seller that a buyer is serious and has some actual skin in the game.
Here’s how it works . . .
“Earnest money is put down before closing on a house to show you’re serious about purchasing. . . . When a buyer and seller enter into a purchase agreement, the seller takes the home off the market while the transaction moves through the entire process to closing. If the deal falls through, the seller has to relist the home and start all over again, which could result in a big financial hit. Earnest money protects the seller if the buyer backs out. It’s typically around 1% – 3% of the sale price and is held in an escrow account until the deal is complete.”
Then if the deal goes through without a hitch, this earnest money is applied to the down payment and/or closing costs. But in the case that the deal falls through for some reason, the buyer will get her earnest money back.
Go Beyond Financing Terms
Certainly, it’s important to understand these basic real estate financing terms, but the actual application of the concepts contained in the terms can get pretty complicated. That’s why your [market-city] real estate agent is there to assist you. So if you have any questions about these financing terms or are ready to buy or sell real estate in , contact us today at 866-593-7012.