Shopping for a mortgage can involve a steep learning curve. For many, it's a strange, new world of alien concepts and unfamiliar words. Adding to the confusion is that many of those concepts and words seem to be similar in meaning, but are actually quite different.
Here are six pairs of mortgage terms that are commonly misunderstood or confused with each other. While each pair of words or terms are related in some way, they actually have very different meanings.
1 - Pre-qualified vs pre-approved
This is probably the pair of terms that cause the most confusion. Being pre-qualified basically means getting a lender's ballpark estimate of how much you'd be able to borrow, based on information you provide about your income, debts and credit standing. None of this information needs to be verified.
Getting pre-approved is a more substantial step. To do that, you need to submit a preliminary application that allows a lender to check your credit, income, employment and other relevant information. You'll often need to pay a fee. In return, the lender responds with a commitment to lend you a certain a certain amount of money on certain terms - including the interest rate and any fees - if you find a suitable property.
The advantage of a pre-approval is that you can show it to a home seller as evidence of your ability to buy the property. However, it is not a hard-and-fast commitment from the lender to approve the loan. For that to happen, the property you choose must pass an appraisal and title search, and sometimes an inspection as well, before the lender will sign off on the loan.
2 - Lender vs. broker
These are two terms that people sometimes use interchangeably, but which refer to different types of mortgage vendors. A lender is an entity - such as a bank - that actually lends the money for mortgages and has authority to approve such loans. It may also refer to someone who works for that entity and has the authority to approve mortgages on its behalf.
A broker, on the other hand, is a third-party agent that helps arrange mortgages between a lender and a borrower. A broker often has relationships with multiple lenders, all of whom offer various mortgage products, and so can match borrowers with the product that suits them best. A lender, on the other hand, only markets its own line of mortgage products.
For a customer, it can often be difficult to tell whether you're dealing with a lender or a broker up front. Both appear to do business and advertise loan products in much the same way. A lender may identify itself as a "direct lender," meaning you're dealing with the entity that actually makes the loans, while a broker may not always identify itself as such. You may not realize you're dealing with a broker until you receive loan documents with the name of the actual lender on them.
3 - Lender vs. servicer
A servicer is another entity that people often confuse with lenders. But the two play completely different roles in the mortgage business.
A mortgage servicer is the company that handles the tasks associating with administering a mortgage during the life of the loan. It's the entity that sends your monthly mortgage statement and which you send your payments to. It handles such things as the escrow accounts for your property taxes and homeowners insurance. It's also the entity that initiates foreclosure proceedings against borrowers who become delinquent on their payments.
What many people don't realize is that lenders usually don't hang onto the mortgages they issue. While some will keep mortgage loans on their books with the intent of profiting from the interest over time, it's more common for lenders to almost immediately sell the loans to investors and profit solely from the origination fees. When this happens, a servicer is needed to manage the loan, collect the payments and pay the investors.
Some companies, such as major banks, serve as both lenders and servicers, although the functions are separate and the loans they service need not be ones they originated. Other entities serve strictly as lenders or banks, and others limit themselves to servicing. If you get a loan from a lender that keeps the mortgage on its books, as credit unions and small mortgage banks often do, your lender is also your servicer.
4 - Inspection vs. appraisal
These are two actions that are superficially similar but serve very different purposes. Both involve an evaluation of the property under consideration.
An inspection is typically required by a potential buyer to identify potential defects in a property. A real estate inspector is hired to go through the property and look for problem areas, such as weakened foundations, black mold, signs of water damage, repairs or improvements that are not up to code and the like. Generally, they're on the lookout for things that might cost the buyer significant money to correct in the near future.
An appraisal, on the other hand, is required by the lender in order to determine if the fair market value of the property will support the mortgage. They want to make sure you're not overpaying for the property they're lending you money to buy. While an appraiser may take the general condition of the home into account, in general they're more interested in the overall description of the property - square footage, number of rooms, bathrooms, year built, size of the lot, whether it has a finished basement, etc. A major factor for an appraiser will be "comparables" or the recent selling price of similar homes in the neighborhood and others nearby.
5 - Credit report vs. credit score
These are two things that get mixed up so often that many people aren't even aware there's a difference. Your credit report is a record of how you've handled your credit - a line-by-line summary of the status of your various credit cards, auto loans, mortgages, etc. and of how you've handled them. The report will note the current status of your accounts, whether they're paid or past due, the balance owed on each, the amount of credit available, any delinquencies over the past seven years and the like. Bankruptcies and foreclosures are noted as well, up to 10 years after the fact.
Your credit score is a three-digit number that summarizes the state of your credit report. If your credit report shows you've done a good job of handling your credit, you'll have a high score. If you've fallen behind by several months on some of your payments or had one or more accounts written off as uncollectable, you'll have a low score. The credit score is one of the things lenders look at when deciding to approve a loan - it's much faster than going over your entire report themselves.
As you may know, federal law states that you're entitled to a free copy of your credit report once a year from each of the three credit reporting companies - Equifax, Experian and Transunion. What many people do not realize is that this does not mean they are entitled to their credit score free of charge as well. You usually have to pay for that, particularly if it's your FICO score, which is the main one mortgage lenders use.
6 - Refinance vs. loan modification
Both of these can perform similar functions - lowering your monthly mortgage payment - but they do so in completely different ways.
A mortgage refinance is when you take out a brand new mortgage, with new terms, and use it to pay off the old one. In other words, you replace the old mortgage with a new one.
There are several reasons for doing this, such as getting a lower interest rate, shortening the term of the loan, combining a high-interest home equity loan and primary mortgage into a single loan at a low rate, etc. The main thing is that you're taking out a new mortgage and need to qualify for it all over again.
A loan modification, on the other hand, is an adjustment of the terms of your existing mortgage. This is often done when a borrower is having difficulty making payments, so the mortgage servicer agrees to certain changes to prevent foreclosure - extending the terms of the loan, lowering the interest rate, temporarily deferring interest payments, etc. This is done solely at the servicer's option, although government programs such as HAMP may provide incentives and guidelines for doing so.
A loan modification will likely ding your credit, since it means you are not paying the loan as originally promised. A refinance, on the other hand, does not affect your credit since you are simply paying off the old loan, as you are allowed to do under the terms of the mortgage.