Financing Terms You Need To Know:
While working with your mortgage company, you may come in contact with terms or phrases that are unfamiliar. The financial language you need to understand in order to make informed decisions about your home loan includes the following:
A-Credit: A consumer with the best credit rating, deserving of the lowest prices that lenders offer. Most lenders require a FICO score above 720. There is seldom any payoff for being above the A-credit threshold, but you pay a penalty for being below it.
Adjustable-Rate Mortgage (ARM): A mortgage loan with an interest rate that can change at any time, usually in response to the market or Treasury Bill rates. These types of loans usually start off with a lower interest rate comparable to a fixed-rate mortgage.
Amortize: Paying off a debt by making regular installment payments over a set period of time, at the end of which the loan balance is zero.
Annual Percentage Rate APR: The Annual Percentage Rate, which must be reported by lenders under Truth in Lending regulations. It is a measure of credit cost to the borrower that takes account of the interest rate, points, and flat dollar charges by the lender. The charges covered by the APR also include mortgage insurance premiums, but not other payments to third parties, such as payments to title insurers or appraisers. The APR is adjusted for the time value of money, so that dollars paid by the borrower up-front carry a heavier weight than dollars paid in the future. However, the APR is calculated on the assumption that the loan runs to term, and is therefore potentially deceptive for borrowers with short time horizons.
Assumption: A method of selling real estate where the buyer of the property agrees to become responsible for the repayment of an existing loan on the property. Unless the lender also agrees, however, the seller remains liable for the mortgage.
Balloon Mortgage: A mortgage loan with low interest payments initially, but then requires one large payment due upon maturity (for example, at the end of seven years).
Bridge Loan: A short-term loan, usually from a bank, that “bridges” the period between the closing date of a home purchase and the closing date of a home sale. Unsecured bridge loans are available if the borrower has a firm contract to sell the existing house. Secured bridge loans are available without such a contract.
Buy-Down Mortgage: A mortgage loan in which one party pays an initial lump sum in order to reduce the borrower’s monthly payments.
Cash-Out Refi: Refinancing for an amount in excess of the balance on the old loan plus settlement costs. The borrower takes “cash-out” of the transaction. This way of raising cash is usually an alternative to taking out a home equity loan.
Collections: The efforts a lender takes to collect past-due payments.
Convertible ARM: An adjustable-rate mortgage loan that can be converted into a fixed-rate mortgage during a certain time period.
Credit Score: A single numerical score, based on an individual’s credit history that measures that individual’s credit worthiness. Credit scores are as good as the algorithm used to derive them. The most widely used credit score is called FICO for Fair Issac Co. which developed it.
Deed: A legal document under which ownership of a property is conveyed.
Delinquency: Failure to make a payment when it is due. A loan is generally considered delinquent when it is 30 or more days past due.
Documentation Requirements: The set of lender requirements that specify how information about a loan applicant’s income and assets must be provided, and how it will be used by the lender.
Down Payment: The difference between the value of the property and the loan amount, expressed in dollars, or as a percentage of the price. For example, if the house sells for $100,000 and the loan is for $80,000, the down payment is $20,000 or 20%.
Due-On-Sale Clause: A provision of a loan contract that stipulates that if the property is sold the loan balance must be repaid. This bars the seller from transferring responsibility for an existing loan to the buyer when the interest rate on the old loan is below the current market. A mortgage containing a due-on-sale clause is not an assumable mortgage.
Effective Rate: A term used in two ways. In one context it refers to a measure of interest cost to the borrower that is identical to the APR except that it is calculated over the time horizon specified by the borrower. The APR is calculated on the assumption that the loan runs to term, which most loans do not. In most texts on the mathematics of finance, however, the “effective rate” is the quoted rate adjusted for intra-year compounding. For example, a quoted 6% mortgage rate is actually a rate of .5% per month, and if interest received in the early months is invested for the balance of the year at .5%, it results in a return of 6.17% over the year. The 6.17% is called the “effective rate” and 6% is the “nominal” rate.
Equity: Ownership interest in a project after liabilities are deducted – also referred to as your assets.
Escrow: A lender-held account where a homeowner pays money toward taxes and insurance on a home.
Escrow Account: The actual account where the escrow funds are held in trust.
Fixed-Rate Mortgage: A mortgage loan in which the interest rate remains the same for the life of the loan.
Fannie Mae: One of two Federal agencies that purchase home loans from lenders. (The other is Freddie Mac). Both agencies finance their purchases primarily by packaging mortgages into pools, then issuing securities against the pools. The securities are guaranteed by the agencies. They also raise funds by selling notes and other liabilities.
FHA Financing: Home purchase financing offered through the Federal Housing Administration.
Freddie Mac: One of two Federal agencies that purchase home loans from lenders. The other is Fannie Mae.
HARP Program: The Home Affordability Refinance Program (HARP) was started by Fannie Mae and Freddie Mac in 2010 to provide refinancing to borrowers with loan-to-value ratios too high to be eligible for their standard programs.
Home Equity Line Of Credit (HELOC): A mortgage set up as a line of credit against which a borrower can draw up to a maximum amount, as opposed to a loan for a fixed dollar amount. For example, using a standard mortgage you might borrow $150,000, which would be paid out in its entirety at closing. Using a HELOC instead, you receive the lender’s promise to advance you up to $150,000, in an amount and at a time of your choosing. You can draw on the line by writing a check, using a special credit card, or in other ways.
Interest-Only Mortgage: A mortgage where the borrower pays only the interest on the loan for a specified amount of time.
Interest Rate Ceiling: The highest interest rate possible under an ARM contract; same as “lifetime cap.” It is often expressed as a specified number of percentage points above the initial interest rate.
Loan-To-Value Ratio (LTV): The loan amount divided by the lesser of the selling price or the appraised value. Also, referred to as LTV. The LTV and down payment are different ways of expressing the same set of facts.
Loan Origination Fees: Fees paid to your mortgage lender for processing the mortgage application. This fee is usually in the form of points. One point equals 1% of the mortgage amount.
Lock-In Rate: A written agreement guaranteeing a specific mortgage interest rate for a certain amount of time.
Maximum Loan Amount: The largest loan size permitted on a particular loan program. For programs where the loan is targeted for sale to Fannie Mae or Freddy Mac, the maximum will be the largest loan eligible for purchase by these agencies. On FHA loans, the maximums are set by the Federal Housing Administration, and vary somewhat by geographical area. On other loans, maximums are set by lenders.
Mortgage: A legal document that pledges property to a lender as security for the repayment of the loan. The term is also used to refer to the loan itself.
Mortgage Broker: An independent finance professional who specializes in bringing together borrowers and lenders to complete real estate mortgages.
Mortgage Insurance (PMI): Insurance that protects lenders against losses caused by a borrower’s default on a mortgage loan. Mortgage insurance (or MI) typically is required if the borrower’s down payment is less than 20 percent of the purchase price.
Mortgage Lender: The lender providing funds for a mortgage. Lenders also manage the credit and financial information review, the property and the loan application process through closing.
Negative Amortization: A rise in the loan balance when the mortgage payment is less than the interest due; Sometimes called “deferred interest.”
Option ARM: An adjustable rate mortgage with flexible payment options, monthly interest rate adjustments, and very low minimum payments in the early years. They carry a risk of very large payments in later years.
Origination Fee: An upfront fee charged by some lenders, usually expressed as a percent of the loan amount. It should be added to points in determining the total fees charged by the lender that are expressed as a percent of the loan amount. Unlike points, however, an origination fee does not vary with the interest rate.
Piggyback Mortgage: A combination of a first mortgage for 80% of property value, and a second for 5%, 10%, 15%, or 20% of value. These combinations are designated as 80/5/15, 80/10/10, 80/15/5, and 80/20/0, respectively. Piggybacks are a substitute for mortgage insurance for borrowers who cannot put 20% down.
Points: An upfront cash payment required by the lender as part of the charge for the loan, expressed as a percent of the loan amount; e.g., “3 points” means a charge equal to 3% of the loan balance. It is common today for lenders to offer a wide range of rate/point combinations, especially on fixed rate mortgages (FRMs), including combinations with negative points. On a negative point loan the lender contributes cash toward meeting closing costs. Positive and negative points are sometimes termed “discounts” and “premiums,” respectively.
Pre-Approval Letter: A letter from a mortgage lender indicating that you qualify for a mortgage of a specific amount. It also shows a home seller that you’re a serious buyer.
Prepayment penalty: A charge imposed by the lender if the borrower pays off the loan early. The charge is usually expressed as a percent of the loan balance at the time of prepayment, or a specified number of months interest.
Pre-Qualification Letter: A letter from a mortgage lender that states that you’re pre-qualified to buy a home, but does not commit the lender to a particular mortgage amount.
Qualification Requirements: Standards imposed by lenders as conditions for granting loans, including maximum ratios of housing expense and total expense to income, maximum loan amounts, maximum loan-to-value ratios, and so on. Less comprehensive than underwriting requirements, which take account of the borrower’s credit record.
Refinance: Paying off an existing loan (such as a balloon mortgage) with a newer, usually lower-rate loan.
Reverse Mortgage: A loan to an elderly home owner on which the balance rises over time, and which is not repaid until the owner dies, sells the house, or moves out permanently.
Second mortgage: A loan with a second-priority claim against a property in the event that the borrower defaults. The lender who holds the second mortgage gets paid only after the lender holding the first mortgage is paid.
Seller Financing: Provision of a mortgage by the seller of a house, often a second mortgage, as a condition of the sale.
Servicer: A firm that performs functions in support of a mortgage, including collecting mortgage payments, paying the borrower’s taxes and insurance and generally managing borrower escrow accounts.
Subordinate Financing: A second mortgage on the property which is not paid off when a new loan is taken out. The second mortgage lender must allow subordination of the second to the new first mortgage.
Title: The documented evidence that a person or organization has ownership of real property.
Title Insurance: Insurance that protects lenders and homeowners against legal problems with the title.
Underwriting: The process a lender uses to determine loan approval. It involves evaluating the property and the borrower’s credit and ability to pay the mortgage.
Uniform Residential Loan Application: A standard mortgage application your lender will ask you to complete. The form requests your income, assets, liabilities, and a description of the property you plan to buy, among other things.
VA Financing: A mortgage with no down payment requirement, available only to ex-servicemen and women as well as those on active duty, on which the lender is insured against loss by the Veterans Administration.
Wrap-Around Mortgage: A mortgage on a property that already has a mortgage, where the new lender assumes the payment obligation on the old mortgage. Wrap-around mortgages arise when the current market rate is above the rate on the existing mortgage, and home sellers are frequently the lender. A due-on-sale clause prevents a wrap-around mortgage in connection with sale of a property except by violating the clause.
The previous “Financing Terms You Need To Know” are not all the financing trerms available. However, these are the main terms that you should know.