Mortgage Jargon Buster: Key Terms Every Homebuyer Should Know

Loan Fundamentals

When you apply for a home loan, lenders look at big-picture numbers and breakdowns. A few core concepts pop up over and over:

Loan-to-Value (LTV) Ratio

Your LTV ratio compares how much you’re borrowing to the value of the home. For example, if you buy a $100,000 house and borrow $80,000, your LTV is 80% (because $80,000 is 80% of $100,000). The lower your LTV (meaning you put more down up front), the less risk the loan is for the lender. In fact, loans with LTVs above about 80% often trigger PMI – private mortgage insurance – adding extra cost each month.

Principal vs. Interest

Every mortgage payment is split into two parts: principal and interest. The principal is the amount that goes toward repaying the loan balance. The  interest is the fee the lender charges you to borrow the money. Early on, most of your payment covers interest; over time, more goes to reducing principal. (A helpful way to remember: interest is the loan’s rent, and principal is the actual debt reduction.) CFPB explains: The principal is the amount you borrowed and have to pay back, and interest is what the lender charges for lending you the money.

Amortization

Amortization is the process of paying off the loan over time through regular, scheduled payments. Each payment first covers that month’s interest, then the rest lowers the principal. Think of it like slicing a loaf of bread, you slowly carve away at the debt. Over the life of the loan, you’ll usually end up paying much more than you borrowed because of interest, especially in the early years. (If you ever see an amortization schedule, it will list each payment’s split between interest and principal.) These payments are divided between principal, or the amount borrowed, and interest so the loan gradually shrinks.

Types of Mortgages

Home loans come in different flavors. The two big categories are fixed-rate and adjustable-rate mortgages:

Fixed-Rate Mortgage

A fixed-rate mortgage locks in the same interest rate for the entire loan term This means your principal and interest payment stays the same every month (assuming no insurance/tax changes). Fixed rates are simple and predictable great if you plan to stay in the home for many years. In Sparrow’s words, “the longer you reside at a property, the more likely a fixed-rate mortgage makes sense”. The trade-off is you might pay a slightly higher rate than an adjustable loan, but you get stability in return.

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage (ARM) starts with a fixed rate for a set period, then “adjusts” (up or down) periodically per the loan terms. For example, a 5/1 ARM might have a fixed rate for 5 years, then reprice annually. As BECU explains, “a mortgage that will have a fixed rate for a set period and then an adjustable rate per the terms of the loan agreement. ARMs can offer a lower initial rate, but watch out: after the fixed period, rates can rise. They can be a smart choice if you plan to move or refinance before the adjustment kicks in. Otherwise, be prepared for a payment that changes over time.

Insurance & Escrow Accounts

Lenders use insurance and escrow accounts to manage risk and ensure key bills get paid on time:

Private Mortgage Insurance (PMI) – explained

If your down payment (and thus your LTV) is less than about 20%, most conventional loans require PMI. What is PMI? Essentially, it’s insurance for the lender, not you. The CFPB puts it plainly: PMI protects the lender not you if you stop making payments on your loan. In other words, PMI is a safety net for the lender in case of default. It’s automatically added to your mortgage payment until you build enough equity (usually when your LTV drops below 80%). It can add a few hundred dollars per month in fees. The good news is once your home equity is high enough (or you refinance), you can usually cancel PMI. Just remember: PMI lets you buy a home sooner (with less down), but it  does increase your cost of borrowing.

Escrow Account

An escrow account is like a holding account for certain homeownership expenses. Instead of paying taxes and insurance bills yourself, the lender collects a portion of those costs with your mortgage payment and pays them on your behalf. In practice, that means part of each monthly mortgage payment gets set aside in escrow. The BECU glossary defines it simply: An account that holds a portion of your monthly mortgage payment that may be applied to property tax and homeowner’s insurance. In many loans, the lender even opens the escrow account for you; you pay every month as part of your mortgage. This ensures taxes and insurance are paid on time without you having to remember it.

For example, on a typical mortgage the escrow portion covers things like:

• Property taxes (paid yearly or semi-annually)
  
  
• Homeowners insurance (paid annually)
  
  
• (In some cases) Mortgage insurance premiums if applicable.
  
  

Lenders often require escrow accounts so they know those obligations will be met. It adds a bit to your monthly payment, but it’s one-stop shopping: no big lump-sum tax or insurance bills to track down on your own.

Costs, Fees & Points

Buying a home comes with a variety of additional costs. Here are some key ones every borrower encounters:

Closing Costs

Closing costs are the collection of fees and charges you pay at the final signing of the home loan. They usually run about 2–5% of the loan amount. These are not part of your loan balance but must be paid in cash (or sometimes rolled into the loan). Closing costs can include origination fees, title fees, prepaid insurance/taxes, and more. For example, common buyer’s closing costs often include:

• Home inspection fee – to check the house’s condition.
  
  
• Appraisal fee – to verify the home’s value.
  
  
• Title insurance – protecting you (or the lender) against title issues.
  
  
• Escrow and recording fees – charges from the title company to handle the closing paperwork.
  
  
• One year of homeowners insurance – often paid up front.
  
  
• Prepaid property taxes – up to six months of taxes in advance.
  
  
• Lender fees – including origination, credit report, and underwriting charges.
  
  

The fees collected at the end of a real estate transaction make up the closing costs. You’ll get a Loan Estimate and Closing Disclosure that break these down line-by-line before signing, so no surprises. It’s smart to budget for closing costs early on so you’re not caught off-guard at the finish line.

Points (Discount Points)

Points, also known as discount points, let you trade money up front for a lower interest rate. Each point is equal to 1% of the loan amount. For instance, on a $200,000 loan, 1 point costs $2,000. When you pay a point at closing, the lender typically reduces your interest rate (often by about 0.25%, though it varies). The CFPB explains: Points lower your interest rate, in exchange for paying more at closing. In practice, paying points is worthwhile if you plan to stay in the loan long enough to “break even” on that upfront cost through monthly savings. If you only plan to keep the loan a few years or have limited cash, it might not be worth it. Always ask your lender to run the numbers: one example could be paying 2 points ($4,000 on a $200k loan) to shave 0.5% off your rate. If that saves you $50 per month, you’d recoup the $4,000 in about 80 months (plus still benefit beyond that). In short, points can be a good deal if you do the math.

Mortgage Applications & Approval

Pre-Qualification vs. Pre-Approval

You’ll likely hear two similar-sounding terms before shopping for a home: prequalification and preapproval. They both give you an idea of what you can borrow, but are not the same:

• Pre-qualification is a quick, informal estimate. You tell the lender about your income, savings, and debts (often without paperwork), and they give you a rough idea of how big a loan you might afford. It usually involves only a soft credit check (which doesn’t hurt your score). It’s fast and easy, but not binding. Because it’s based on unverified info, Rocket Mortgage warns that pre qualification provides a less reliable estimate of your loan amount than a preapprovalPrequalification is useful early on to narrow your home search budget.
  
  
• Pre-approval is more official. The lender actually reviews your documents – pay stubs, bank statements, tax returns – and does a hard credit pull. Then they issue a letter stating how much you’re approved to borrow (assuming nothing changes). This usually carries more weight with sellers. A mortgage preapproval requires the lender to verify your financial information and credit history and you’ll receive a preapproval letter confirming it.. Preapproval shows you’re a serious buyer and tells real estate agents your maximum loan amount.
  
  

In short, prequalification = quick estimate (soft credit check), preapproval = verified approval (hard check). We recommend getting preapproved before you make an offer.

Underwriting

Once you’re under contract on a home and have submitted your mortgage application, it goes to underwriting. This is the lender’s final review step. The underwriter checks that your income, assets, debt, credit, and the home’s appraisal all meet the lender’s guidelines. They may ask for extra documents (like proof of an unexpected bank deposit). Think of underwriting as quality control for your loan. It can feel like the homebuying process grinds to a halt, but rest assured, it’s normal. The quicker you get any requested paperwork to the lender, the smoother underwriting goes. Once you’ve cleared underwriting, you’re in the home stretch toward closing!

You’ve Got This!

There it is your mortgage glossary cheat sheet. Whether you’re quoting an LTV ratio, wondering “What’s an escrow account?”, or debating if a 5/1 ARM is right for you, remember, it’s okay to ask questions. Sparrow Home Loans and our team of mortgage experts love walking homebuyers through this process. We promise to speak in clear, plain English (and maybe crack a joke or two) so you never feel lost. The journey to homeownership has a lot of moving parts, but with this jargon busted, you can move forward confidently. Feel free to reach out any time to discuss your options, get a pre-approval, or just brainstorm strategies. We’re here to be your guide, cheerleader, and go-to resource on this exciting road. Happy home shopping you’re ready to take on those mortgage terms like a pro!