Buying a home is a major and exciting milestone in life, but one that can feel a bit intimidating at times. However, armed with the proper knowledge and understanding, you can make the process of finding your dream home much simpler.
In this blog, we'll review ten terms every homebuyer should know. By understanding these terms and processes, you'll better prepare yourself and maybe even save yourself some money and time down the line.
A pre-approval is a written commitment from a lender that specifies how much you’d be approved to borrow. While a strong indicator that you’ll be approved for a loan, a pre-approval is not a guarantee that you will be approved. In the pre-approval letter, lenders will determine how much you’re able to borrow by looking at your credit, income, existing debts, and more.
Pre-approvals are common for most types of loans, especially when it comes to mortgages. By getting pre-approved, you present as a stronger and more serious candidate when buying a home. Be sure to talk with your real estate agent and review what documentation you’ll need to submit for a pre-approval.
You can think of the purchase agreement for a home as the contract dictating the terms and conditions of your transaction. Both the buyer and the seller play a part in the agreement, which outlines each party’s respective conditions, obligations, and responsibilities. The seller will typically contribute their conditions to the purchase agreement once they’ve accepted your offer.
Purchase agreements are important for different types of real estate transactions, including both private and commercial sales. Without a purchase agreement, neither the buyer nor the seller has any protections in the transaction. Real estate agents (and attorneys) and title companies often prepare purchase agreements.
An earnest money deposit (EMD), commonly called a “good faith deposit,” is a small sum of money that you attach to your offer to purchase a home or property. Typically between 1-3% of the total, this deposit helps show the seller that you’re serious about purchasing the home and are willing to put money towards it.
An EMD is different from a down payment, which you’ve probably also heard of. A down payment is due at the time of closing and is money that goes towards your lender, not the seller. While the total you place in a down payment also varies, it’s generally closer to 20-30% in most cases.
Contingencies are clauses that are added into your purchase agreement that define your expectations and needs for a purchase or sale to go through. Elements that are commonly identified as contingencies include:
Appraisals
There are contingencies that can be added into a purchase agreement that protect both the homebuyer and seller. For instance, the buyer can insert a contingency relating to a home inspection, while the seller may include contingencies for timelines relating to financing or appraisals.
A down payment is the money you put towards your mortgage when you’re first buying a home. It’s generally anywhere from 3 – 20% of the total mortgage. The amount you put down will ultimately be determined by how much you can afford, as well as any conditions or elements unique to your loan. Your down payment represents the portion of your home that you own outright, or its equity.
You’ll often hear that you need to pay 20% in your down payment, which is not true. While 20% is an excellent option if you can afford it, you can still buy a home with a smaller down payment. But remember, the more you put towards the home up front, the less you’ll need to pay off over the term of your mortgage.
Closing costs are the fees you’ll need to pay that help fund your mortgage and transfer the home from its previous owner to you. They’re called closing costs as they’re due and paid at the time of closing. For a homebuyer, closing costs are generally 3-6% of your mortgage amount, though it depends on the type of mortgage you have.
The fees that are included in closing costs are:
Recording fees
An appraisal is an estimation of the value of a property. You’ll work with your lender to have an appraisal completed by a professional appraiser. The appraiser will complete an assessment of the property without any influence from the lender, buyer, or whoever’s interest the appraisal is in.
Appraisals are important components of not only the homebuying process, but also in refinancing and selling. Lenders often require home appraisals to ensure you aren’t borrowing more than what the home is worth. As such, it’s important to have the home’s estimated appraisal price be the same as your mortgage amount or higher.
If the appraisal comes in lower than you’d hoped for, you can have a second appraisal completed. Appraisers will look at a variety of factors, including the property itself, its age and condition, amenities, special features, and what other homes in the area recently sold for.
While a home inspection may sound like an appraisal, it’s quite different. A licensed home inspection agent or agency can complete your home inspection, where they will take an in-depth look at your prospective home. This includes taking a close look at the home’s structure, its appliances (such as the HVAC unit and water heater), its plumbing, its electrical units, its roof, and more.
From here, you’ll receive a report on the inspection that details all the agent’s findings and their recommendations. If their suggestions are minor and don’t require immediate attention (in your opinion), it’s then at your discretion to act on those recommendations. If the home you’re looking at fails its inspection, you have some options, such as:
Walking away from the purchase if the repairs seem too immense
With a failed home inspection, be sure to trust your gut instincts. While buying a home is a major life event and milestone, the safety of you and your family will always be most important. If the home inspection raises some major red flags, don’t feel bad about needing to walk away.
Escrow can mean a few different things. When it comes to homebuying, escrow is a third-party account where funds are deposited until the home purchase is complete. For instance, the money you put forth in your EMD would be held in an escrow account. Once you close on the home, the funds in escrow would be distributed accordingly.
There are also mortgage escrow accounts, which are applicable to homeowners. Lenders will often keep some of the borrower’s money in an escrow account to cover funds like taxes and insurance. Your lender will monitor this escrow account and ensure that the funds are used accordingly.
Private mortgage insurance (PMI) is an added insurance policy for homeowners. PMI is required for homeowners who have a conventional mortgage (a mortgage not backed by the government) or make a down payment of less than 20%. This insurance policy provides protection to your lender in the event you fail to pay back your mortgage.
PMI is factored into your monthly mortgage payment and depends on your loan-to-value ratio, or the amount you owe towards your mortgage compared to your home’s current value. Once you’ve built up 20% or more equity in your home, you may be able to remove PMI from your monthly payment. However, some loans, such as Federal Housing Administration (FHA) loans, may require PMI for the entirety of your mortgage’s term.