The LearnVest Vocab Lesson: 8 Terms to Know Before You Buy Your First Home

Family in front of house

This post originally appeared on LearnVest.

Congrats! You’ve diligently saved up a down payment, run the numbers on what you can realistically afford and probably attended enough weekend open houses to know you’re ready to call a home your own. Of course, you may need an extra loan to help with any renovations that may be required after you move in, luckily you can use this bridging loan calculator to explore the amount you may need an how much you will have to pay back.

Now comes the actual buying part.

While it’s an exciting milestone, purchasing a first home can also seem terrifying. After all, it’s one of the biggest money decisions you’ll ever make. And getting hit with a whole new language of unfamiliar finance terms can only add to the stress.

The good news is that home buying doesn’t have to be daunting. While we can’t help you decide between a ranch or a townhouse, we can give you the tools to help make sure your decision is financially sound.

So to cut out some confusion, we’ve rounded up eight of the most important home-buying terms and translated each into plain English. Consider this your cheat sheet to common real estate and mortgage lingo.

1. ARM

ARM stands for adjustable rate mortgage. Simply put, it’s a type of home loan where your interest rate will change over time.

Most ARMs start off with a short period of a set low interest rate. But after that time is up-typically between three and 10 years-your rate becomes adjustable. That means it’ll reset periodically, based on what’s going on in the market. So if interest rates start sliding, you could be saving money. But the opposite can also happen: If rates rise, your monthly payment could suddenly skyrocket.

If you’re the type of person who likes a little more certainty in your life, you probably wouldn’t love an ARM. On the other hand, if you’re not shopping for your forever home and plan to move before the fixed-rate period expires, an ARM could be a good option.

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2. Fixed-Rate Mortgage

This type of home loan is a little more old-school than an ARM, and it’s a lot more straightforward.

Whereas ARM interest rates go where the market goes, think of a fixed-rate mortgage as a more dependable choice, for better or for worse: You’ll be committed to a single interest rate for the life of the loan.

That comes with its pros and cons. For example, if interest rates in the market drop, you’re stuck with your higher rate. (That is, unless you refinance, which can mean some hassle and fees.) Still, if interest rates rise, you won’t have to stress about suddenly having a bigger home payment.

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3. Assumable Mortgage

This is a less common type of mortgage (typically for ones administered by the Federal Housing Administration or U.S. Department of Veterans Affairs) where, instead of taking out a new loan, you simply take over the seller’s old mortgage.

That may sound like a great deal-doesn’t “pre-owned” always mean savings?-but it’s a little more involved than, say, buying a used car.

It typically only makes sense if interest rates are rising. For example, if the owner’s mortgage was fixed at 3%, and rates right now are 5%, you’d stand to save on interest. Bonus: You’ll also likely pay less in fees, since you aren’t getting a brand-new mortgage. (Though you will still have to be approved by the seller’s lender.)

Plus, say you’re buying the home for $250,000 and the mortgage balance is just $150,000. You’ll still have to find a way to cover that difference, whether that’s coming up with a bigger down payment or taking out a second mortgage.

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4. Balloon-Payment Mortgage

This is a type of mortgage where after just five or seven years of low monthly payments, you’re expected to pay off the rest of the home in one, big lump sum at the end-hence, the “balloon.”

Yes, it’s a lot of cash to suddenly come up with. But in reality, most people never actually plan to pay that big balance at once. Rather, they’ll sell their home before then or simply take out a new loan when the balloon payment comes due.

The big advantage? The interest rate for those five or seven years tends to be really low.

Here’s the risk, though: There’s no guarantee you’ll be approved for another loan once that big payment is due. For example, say your home’s value has fallen over time, or you’ve weathered a big pay cut at work. That’ll make getting a new mortgage on the fly much harder.

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5. Equity

Equity tells you how much of your home you really own. In short, it’s the current market value of your house minus the amount you still owe on the mortgage. For example, let’s say your ranch house is worth $300,000 right now, but you’re still on the hook for $150,000 in mortgage payments. You really only “own” $150,000 of the home. In other words, you have 50% equity.

As you keep making those monthly payments, your equity will grow. It can also change as the value of your home goes up (or down).
Once you’re approaching the age of 55 and above, you may consider equity release to help ease your financial worries and improve your quality of life.

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6. Escrow

“Escrow” can get confusing, because it actually has two different meanings in the real-estate world.

First, after your offer has been accepted on the home, some money will be kept in a separate escrow account until all the conditions of the contract are met. It’s a way to protect both the buyer and seller.

For example, as the buyer, you don’t want to hand over any money until you’re sure the home passes inspection. But the seller also wants some kind of assurance that you’ll actually pay before they take the home off the market.

So an escrow agent comes in as the referee. They hold a certain amount of cash from the buyer in this escrow account, along with documents from the seller, like the deed to the house. Once the contract is signed, all the assets are handed out.

But escrow account takes on a second meaning when you become a homeowner. Because your mortgage lender wants to make sure you actually pay your property tax and homeowner’s insurance, they collect extra money from you every month and hold it in an “escrow account.” They’ll then use that money to pay those annual expenses for you-and you can both worry less knowing there is money set aside to pay those important bills.

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7. Earnest Money

Earnest money is a way to show a seller that you’re serious about wanting to buy their property. After all, before starting a contract, sellers want to be sure that you’re ready to put a ring on it-and that you’re not just throwing out offers at every open house you attend.

So to show them how “earnest” you really are, you deposit a set amount of money into an escrow account (yep, that term again) with your offer. It’s typically 1% to 3% of the purchase price. If all goes well and the home is yours, that cash can go toward your down payment. On the other hand, if you get cold feet and back out, the seller has an opportunity to pocket that money.

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8. Private Mortgage Insurance

Private mortgage insurance, aka PMI, is a type of insurance policy you’ll have to take out if your down payment is less than 20%.

If you can’t come up with 20%, the mortgage lender views you as a financial risk. So to protect themselves, they make you pay for PMI until you’ve built up a little more than 20% equity in your house. That way, if you end up defaulting, the lender will still get paid via the insurance.

Not only is PMI an extra bill you’ll have to cover every month, but unlike most insurance policies you pay for, your PMI doesn’t protect you-only the lender will be covered if you default. So at LearnVest, we recommend you always try to save up at least 20% for a home down payment-so you can avoid having to pay that PMI.

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About the Author: LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies. LearnVest, Inc., is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company.