This glossary will help you understand some of the terms used throughout the home buying process.
Cash Reserves: The money someone keeps on hand to meet short-term and emergency funding needs. Cash reserves are useful when money is needed right away for unexpected payments or a large purchase or to cover unexpected payments, such as a down payment.
Cosigner: Someone who is added to the mortgage application and other loan documents promising responsibility for the loan, but who doesn’t get any rights to the property. A cosigner must have stable income, a low debt-to-income ratio, and great credit.
Credit Utilization Rate: The amount of credit you have used compared with how much credit you have been extended by a lender.
Graphic: Credit Utilization Rate = Your Total Debt/Your Total Available Credit
Debt/Income Ratio (DTI): This ratio compares monthly debt payments to monthly gross income and provides the percentage of your gross monthly income that goes towards paying your monthly debt payments.
Graphic: DTI = Total monthly debt payments/gross monthly income
How to calculate:
Add up your monthly debt payments including credit cards, loans, and mortgage.
Divide your total monthly debt payment amount by your monthly gross income.
The result will yield a decimal, so multiply the result by 100 to achieve your DTI percentage.
DID YOU KNOW? Generally, 43% is the highest DTI ratio a borrower can have and still get qualified for a mortgage, but lenders prefer a ratio lower than 36%, with no more than 28% of that debt going towards servicing a mortgage or rent payment. You can lower your DTI ratio by reducing your monthly recurring debt or increase your gross monthly income.
Deductions: An expense that can be subtracted from gross income in order to reduce the amount that is subject to income tax.
Down Payment: An upfront payment made in cash when getting a mortgage. Typically, this is 5-20% of the total cost of the home, but there are plenty of options for putting down less than 5%.
Fannie Mae: More formally known as the Federal National Mortgage Association, Fannie Mae is a United States government-sponsored entity which typically buys loans from lenders of all sizes in an effort to make mortgages more affordable and available to low- and middle-income buyers.
FICO Score: A type of credit score created by the Fair Isaac Corporation. Lenders use borrowers' FICO scores along with other details on a credit report in determining whether to provide borrower a mortgage. FICO scores take into account various factors in five areas to determine creditworthiness: payment history, current level of indebtedness, types of credit used, length of credit history, and new credit accounts.
Freddie Mac: More formally known as the Federal Home Loan Mortgage Corporation, Freddie Mac allows for mortgages to be bundled together and sold as investments on the secondary mortgage market. This bundling and selling allows more people to obtain mortgages because the lenders don’t have to hold the loans on their balance sheet, thus freeing up their capital to re-lend and make additional loans.
Gross Income: Your pay before taxes and deductions are taken out.
Loan-to-Value Ratio (LTV): LTV is a ratio used by lenders to determine the amount necessary to put in a down payment whether the lender will extend credit to a borrower. Typically, a loan with a high LTV ratio may require the borrower to purchase PMI to offset risk to the lender.
LTV = Mortgage Amount/Appraised Property Value
Mortgage Insurance Premium (MIP): Specific to an FHA loan, this is required as an upfront cost and as an annual premium for borrowers putting less than 20% down.
Net Income: Your pay after taxes and deductions are taken out.
Private Mortgage Insurance (PMI): The extra monthly insurance that lenders require from most homebuyers who put less than 20% down. Typically, PMI will cost 0.5 percent to 1 percent of the loan over the course of the year.