Paying for a Home: Financial Terms to Know for Your Real Estate Transaction

Paying for a Home: Terms to Know in Real Estate Transactions

Below we cover some of the most common real estate financial terms and options you’ll encounter when considering how to buy your home. 

What is a first time homebuyer program?

First time homebuyer programs help those with low or moderate income or with less than stellar credit scores secure a mortgage to purchase a home. Owning a home is an important piece of the American Dream. It can also positively impact your financial portfolio and help you reach new milestones. First time homebuyer programs are an effective tool for many to take that first step toward homeownership. First time homebuyer programs vary by region or state. 

What does pre-qualified mean?

Pre-qualified is an estimate of what you are able to borrow based on current financial indicators such as income, debt, assets, and others. Getting prequalified is a great first step to take and will help you begin to identify what you can buy. Once you have been prequalified, it’s important to keep your information up to date with your lender. Again, this is a great first step to take, and one that can save you time and energy in the long run!

What does pre-approval mean?

Pre-approval for a mortgage is the preliminary evaluation of a potential borrower by a lender to determine whether the borrower can be pre-qualified for a mortgage.

What is a mortgage?

A mortgage is a loan between you and a lender that allows you to borrow money used to purchase real estate for which that property then serves as collateral. In a mortgage, a borrower and lender agree to terms, and if the terms are not met or the borrower fails to make payment the lender acquires the property. The loan is considered secure because it is backed by an asset - the property - and the lender will in turn accrue interest on the loan paid over time. 

What is a fixed mortgage rate?

A fixed mortgage rate is a loan where the interest on the note remains the same throughout the term of the loan. You pay a set amount with no changes over time. Having a mortgage with a fixed rate is a pretty conservative financial strategy. You can have peace of mind knowing that you are paying the same amount month over month. For some this is a clear way of managing their loan over time.  

What is a preferred lender?

A preferred lender is one entity's preference for a buyer to go through a particular mortgage company for financing. When working with financial and real estate professionals to purchase a home they will often know who is especially skilled and proficient. The intention of working with a preferred lender is to ensure a smooth process from beginning to end. 

What is an interest rate?

An interest rate is the amount a lender charges a borrower and is a percentage of the principal. The interest rate on a loan is typically noted on an annual basis known as the annual percentage rate.  

What is a loan?

A loan is the lending of money from one entity to another. With a loan there is the lender and the borrower. The borrower will pay interest, or a percentage of the principal amount back to the lender over time. 

What is a balloon payment?

A balloon payment is a financing option where a large lump sum is made at any time during the term. Typically we see this in commercial real estate, and typically the large one time payment is made at the end of the term. 

What is an Adjustable Rate Mortgage? (ARM)

An adjustable rate mortgage is a loan with an interest rate that can increase or decrease over a period of time - typically 1 year, 3 years, 5 years. ARM’s currently make up a small percentage of home loans because fixed interest rates are at an all-time low. However as interest rates change, ARM’s could gain popularity as another viable option. 

What is property tax?

Property tax is a tax paid on property owned by an individual or other legal entity. Property tax is determined by a number of factors including but not limited to base value, built up area, age of building/structure and others. Property tax varies by state, so it’s best to become familiar with the property tax in the area you are looking to purchase. Remember to factor in the property tax amount to your monthly payments and expenses. 

What is capital gains tax?

Capital gains tax is the tax on the profit of the sale of an asset. The most common sources of capital gains tax are from the sale real estate, property, stocks, and bonds. For example if you purchase a home at $100,000 and then sell it for $200,000 the profit of $100,000 would then be subjected to the capital gains tax rate. 

What is Alternative Minimum Tax? (AMT)

Alternative minimum tax is a different way of calculating income tax. The AMT began as a way to ensure that wealthy taxpayers weren’t using deductions to avoid paying income tax. The AMT’s purpose is to ensure that every taxpayer pays a minimum amount of tax. So if you’re subjected to the AMT you will calculate your taxes using two methods. If the AMT results in a higher tax bill, you’ll pay the higher tax. 

What is depreciation?

The decline in value to an asset over time. A prime example is when purchasing a new vehicle from a dealership and the moment that vehicle (asset) is driven off the lot it depreciates in value. The good news with real estate and homeownership is that assets typically do not depreciate nearly as drastically as in the example above.  

What is foreclosure?

Foreclosure is a legal process that allows lenders to recover the amount owed on a defaulted loan by taking ownership of and selling the mortgaged property. Foreclosure acts as an element of protection for the lender in the event that the borrower can’t fulfill the loan agreement. 

What is a loan contingency?

A loan contingency is a clause in a real estate contract before the sale of a home is approved. This is a way to protect both the buyer and the seller during the transaction period. An example of this would be if the seller needs to purchase and obtain a new home before the pending sale between the buyer and the seller can close.

What is amortization?

Amortization is an accounting principle used to periodically lower the book value of a loan or an intangible asset over time. Simply put, it’s the process of spreading out a loan into a series of fixed payments whereby the loan is paid off by the end of the payment schedule. 

What is refinancing?

Refinancing is the restructuring or replacement of a debt obligation (terms of a loan) with another debt obligation under different terms. 

What is a fiduciary?

A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties. Typically, a fiduciary prudently takes care of money or other assets for another person.

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If you have any specific questions please share them with us at hello@aalto.com. We’d love to hear from you, and we’re here to help!