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Before You Buy

Real Estate Terms: What to Know Before Buying a Home

12 Minute Read

Real estate can be tricky. Buying a home, selling a home, managing a mortgage—the whole topic can seem overwhelming. It doesn’t help that most people in the real estate and mortgage industry seem to have a language of their own.

If you’re financially ready to buy a home, we can give you some guidance. To help you get started, we’ve put together a list of real estate terms you’ll need to know as a home buyer.

Home Search Terms to Know

Most home buyers are likely to start their search on websites like Realtor and Zillow. But if you want the latest home listings and up-to-date status information, hire a real estate agent. An agent gives you access to a multiple listing service (MLS). This is formed by real estate agents and brokers who compile and submit a list of local and regional properties for sale. An MLS gives you an advantage over competing home buyers who just search free websites.

Listing Abbreviations

As you search through home listings, there are some basic terms and abbreviations you’ll want to know. For starters, a property that’s listed as active is one that’s on the market and available for you to buy. But act fast—other buyers may already be interested.

On the other hand, if you see a home status that is pending, you’ll have to keep looking. Pending means a buyer has made an offer on the home and the seller has accepted. They just have a few more real estate hoops to jump through before the sale is final.

Now let’s decode some common listing abbreviations:

  • BA: Bathroom (e.g., “2.5 ba” means two full bathrooms and one half bathroom)

  • BD: Bedroom

  • DR: Dining room

  • FB: Full bathroom (toilet, sink, and shower/bathtub)

  • FP: Fireplace

  • HB: Half bathroom or powder room (only toilet and sink)

  • LR: Living room

  • SQ FT: Square footage of the home

  • HOA FEE: Homeowner association fee (for neighborhood amenities and maintenance)

  • W/D: Washer and dryer

Home Value Terms to Know

After you’ve reviewed some listings or found the home you want, you need basic knowledge on how homes are valued. Let’s unpack a couple real estate terms associated with how much a home is worth.

First, an appraised value is a professional’s unbiased estimate of a home’s fair market value. Their estimate is based on recent sales of similar homes in the surrounding area called comps or comparables. In a typical mortgage loan process, a lender chooses a licensed appraiser to determine the appraised value of the property you want to buy. This protects you from a home seller who might set an unrealistic or emotionally driven price.

Another term relevant to home worth is assessed value. This estimate is assigned by a local or state government for property tax purposes. Once a value is assigned, the government applies a property tax rate to the assessed value. It’s important to note that a home’s assessed value is often quite different from its appraisal.

Home Financing Terms to Know

A huge part of this whole process is figuring out the financials. The best way is to pay cash for your home. But, because this investment will make up a large chunk of your eventual net worth, a home mortgage—that won’t bust your budget—is the only debt Dave won’t yell about.

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A mortgage is a long-term financial commitment, so make sure you understand these important home financing terms and get all your mortgage questions answered before you sign the bottom line.

Mortgages

For starters, you should know which mortgage options to avoid:

  • Adjustable-Rate Mortgage (ARM): This kind of loan transfers the risk of rising interest rates to you, the homeowner.

  • Federal Housing Administration (FHA): These are more expensive than conventional loans. New regulations require you to pay for private mortgage insurance (more on that later) for the life of the loan.

  • Department of Veteran Affairs (VA): These loans make it easier for veterans to get in a home, but not to pay for the home! Loaded with fees, VA loans usually also carry higher interest rates than conventional loans.

  • 30-Year Fixed Rate: These usually carry the highest interest rate of any mortgage options—which means you’ll pay much more for your house over the life of the loan.

You’ll be debt-free faster and pay much less for your home with a conventional 15-year (or less) fixed-rate mortgage and payments totaling no more than 25% of your monthly take-home pay. With this mortgage option, your interest rate and monthly payment won’t change, so you’ll have plenty of room in your budget to make progress on financial goals. Try our mortgage calculator to estimate your monthly payment and see how much home you can afford.

Private Mortgage Insurance (PMI)

PMI is extra insurance coverage you’re required to buy if you take out an FHA loan or if you finance more than 80% of your home’s value. The coverage protects the lender if you default on your loan but doesn’t go toward paying off your home. In other words, it’s an extra fee that does you no favors.

You can avoid PMI if you save up a down payment of 20% or more of the home’s value. If you already bought your home and put down less than that, not all hope is lost. There are ways to eventually cancel private mortgage insurance.

Annual Percentage Rate (APR)

APR measures the total cost of borrowing money to buy a home. It represents the interest rate, discount points, mortgage broker fees, closing costs, and other charges you pay to get a home loan. With all those factors, the APR is usually higher than your interest rate.

Loan-to-Value (LTV) Ratio

The LTV ratio is the percentage relationship between the amount of a loan and the value of the home. To determine your LTV ratio, divide the amount of the loan by the home’s value or purchase price. For example, if you’re buying a home valued at $300,000 by making a down payment of $60,000 and getting a mortgage of $240,000, you have an LTV ratio of 80%.

$240,000 (loan amount) / $300,000 (home value) = 80% LTV ratio

Lenders use the LTV ratio to evaluate a loan application. High LTV ratios (usually anything above 80%) mean a high risk to lenders and often a higher interest rate for the borrower.

Mortgage Points

Also known as discount points or "buying down the rate," mortgage points are used to determine a one-time fee that’s paid to a lender at closing to reduce the interest rate on a mortgage. One point usually equals 1% of the loan amount. As an example, suppose you pay two points on the $240,000 loan example from above. At closing, those two points would equal $4,800.

$240,000 (loan amount) x .02 = $4,800 owed at closing

As a result, your lender reduces the interest rate and your monthly payment amount. Essentially, this just means you’re prepaying the interest. However, Dave doesn’t usually recommend paying mortgage points because it takes a long time to break even. Instead, put that extra money toward a higher down payment, reducing your loan amount altogether.

Rate Lock

This allows the borrower to secure an interest rate on a mortgage for a certain period of time.

PITI

Pronounced like the word pity, this acronym stands for Principal, Interest, Taxes, and Insurance—the components of a monthly mortgage payment. It’s important to know how much property taxes and homeowner’s insurance will add to your monthly payment so you don’t buy a home you can’t afford.

Preapproved vs Prequalified

A buyer who has completed the mortgage application process and has been approved for a specific loan amount is considered preapproved for a mortgage. This is different from a prequalified buyer—who just talked with a loan officer who has given an opinion on the buyer’s ability to qualify for a home loan. As a buyer, it’s best to be preapproved for a mortgage before you start looking for homes. This shows sellers you’re a serious buyer and places you ahead of the competition. That’s why getting preapproved is an important step for stress-free home buying.

Amortization Schedule

Amortization is a fancy financial term that simply refers to the repayment of a loan over a period of time. An amortization schedule is a table that shows each repayment amount with how much of each payment goes to principal and how much goes to interest over the life of the loan. A 15-year mortgage will amortize (or be paid off) in a shorter time than a 30-year mortgage because more of the monthly payment goes toward principal and less is wasted on interest.

Equity

This is the sales price or market value of a home minus the outstanding balance of any debt owed on the home. For example, suppose the fair market value of your home is $200,000 and you owe $125,000 on the mortgage. Your equity is $75,000. If you sold the house, you would get the equity after you paid off the mortgage.

Home Transaction Terms to Know

By now you found a home, you understand its cost, and you have a smart plan to pay that cost. You’re doing great! At this stage, you’re ready to commit. This is where the real action happens. So, let’s hone in on some terms you’ll want to know during the home transaction process.

Down Payment

Down payment is the amount of cash a home buyer pays at closing (shown as a percentage of the total home price). Save for the largest down payment possible so you can decrease the amount of interest you pay over the life of your mortgage (as mentioned in the PMI section).

Escrow

Escrow is an account with a neutral, third party who receives and manages the exchange of money and documents on behalf of the home buyer and seller prior to the closing of a sale.

Arms-Length Transaction

Arms-length transaction is used to describe a deal in which the buyer and seller act in their own self-interest. Unlike a transaction between relatives or associates, arms-length means neither party is influenced by the other. The buyer wants the lowest price, and the seller wants the highest price. This type of transaction ensures that the property is purchased at fair market value.

Earnest Money Deposit

Earnest money deposit is an amount of money you pay early on in the buying process to show a seller that you’re a serious home buyer. With a high demand for homes, a typical deposit is 2–3% of the offer amount. This deposit is held in an escrow account and goes toward what you owe at closing. And don’t worry. Even if the deal falls through, in many cases you can get most of your earnest money back.

Escalation Clause

Escalation clause is a method used by home buyers to beat out other potential buyers. In the contract, the buyer states they will increase their offer by a certain amount if the seller receives higher offers.

Deed

The deed is a written and signed legal document filed with the local county to prove homeownership. To transfer property to a new owner, the current homeowner must prepare a new deed.

Real Estate Insurance Terms to Know

As you sort through transaction details, there are two types of insurance you should consider. The first is title insurance, which allows you to transfer the risk of an unclean title. An unclean title means there are competing claims of legal ownership on your home. Suppose the house you buy was once inherited by three siblings. If two of the siblings sold you the house without consulting the third sibling, that third sibling could come at any time to claim their legal portion of the inheritance. Title insurance pays off that legal owner and protects your home. That’s why you definitely want to purchase this coverage when house hunting.

The second type of insurance you’ll need is homeowner’s insurance. Usually included in the monthly mortgage payment, this insurance can cover the cost to repair, rebuild, or replace items in your home. Since a house is likely your biggest investment, there’s no wonder why you must have homeowner’s insurance.

Closing Terms to Know

Congratulations—you’re almost a new homeowner! But before you can confidently seal the deal, below are some final real estate terms smart home buyers need to know.

Contingency

When a buyer makes an offer to purchase a home, the contract will usually include contingencies, or conditions that the seller must meet before the contract becomes legally binding. Common contingencies in real estate contracts include a home inspection, appraisal, and financing.

Under Contract

This is when a seller has officially accepted your offer. However, the sale is not considered final until all contingencies are met. If either the buyer or seller fails to meet a contingency, the contract is broken and the other party is allowed to back out of the sale.

Closing Disclosure

This disclosure is a final statement of closing costs and loan terms (such as your monthly payment schedule), which replaced the old HUD-1 settlement form. As the buyer, you can expect to receive the closing disclosure from your lender no less than three business days before you close on the mortgage loan. This time allows you to compare your final costs and terms to those in the Good Faith Estimate (explained below) and ask any unanswered questions.

Closing Costs

These fees and expenses are paid when ownership of a property passes from the buyer to the seller. These include non-recurring fees such as the real estate agent’s commission. In most situations, the seller pays the commission to their listing agent and the buyer’s agent. Other closing costs include:

  • Recording fees
  • Appraisal fees
  • Lender fees
  • Legal fees

Closing costs also include prepaids like property taxes, homeowner’s insurance, and title insurance. The lender must provide you (the borrower) with an estimate of closing costs in a Good Faith Estimate (GFE). But these costs aren’t always set in stone.

If that sounds like a lot of extra money you’ll need to save up, don’t worry: There are plenty of ways to cut closing costs on your home purchase.

Review this list whenever you need clarity during your house hunt and home purchase. You can put your knowledge to work and make smarter decisions faster by working with a real estate professional. Find your real estate agent today!

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