Mortgage Glossary
Adjustable Rate Mortgage (ARM):
A mortgage with an interest rate that fluctuates over the life of the loan, according
to the terms set forth in the mortgage. The interest rate is tied to an index (plus an added margin, and is adjusted at specified
time intervals (the adjustment period.
Typically there is a limit (referred to as the step
on how much the interest rate can rise or fall in a given adjustment period, and
there may also be a lifetime cap that sets a maximum rate.
A convertible ARM allows the borrower to fix the interest rate at a later date.
Adjustment Period: The time interval
between adjustments of the interest rate of an ARM
Adjustment periods can vary from daily to several years. The most common are annually,
semi-annually and monthly.
Amortize: To pay off a mortgage in equal installments. A typical 30 year
mortgage would have 360 equal payments (though the last payment often ends up being
slightly less).
However, if the term of the mortgage is of a shorter duration than the amortization
schedule upon which it is based, it is important to realize that a large amount
may be due at the end of the mortgage. For example, a 30 year amortization due in
10 means that the payments will be structured as though the mortgage were to be
paid over a 30 year period, but the loan will come due after 10 years, with a large
(balloon) payment due for the balance of the principal.
Annual Percentage Rate (APR): The base interest rate of a loan plus all
additional service charges and costs. APR is considered the loan's true rate of
interest, and is shown on the Truth in Lending Statement.
Appraisal: An estimate of the Fair Market Value of a piece of property, arrived at by comparing sales
of similar properties comparables in the local area within
a recent period of time. Replacement cost and income potential of property can also
be a factor in determining value. The appraisal must be done by a licensed appraiser.
Appreciation: The increase in value of a piece of property over time.
Arms Length Transaction: A transaction between parties who have no pre-existing
business or family relationships. All parties are considered to be in an equal bargaining
position and to be acting in their own best interests.
Arrearages: The accumulated delinquent principle, interest, taxes and
insurance the borrower owes the lender.
Assessed Valuation: Value that a taxing authority places on real estate
for taxing purposes.
Assumption: When the buyer of a piece of property agrees to take over
the existing mortgage.
Balloon Loan: When the mortgage repayment
schedule is structured to end with a very large final payment. For example: a loan
amortized over 30 years that is due in 7 years will have payments equal to a 30
year mortgage, but the unpaid balance of the loan will need to be paid off or refinanced
at the end of 7 years. This can lead to problems for the homeowner if their financial
picture changes drastically due to circumstances beyond their control. To help protect
against this, a clause is sometimes included in balloon mortgages allowing for automatic
refinancing when the balloon payment comes due.
Bankruptcy: The process by which an individual or business is relieved
of the payment of debts, after the submission of all assets to a trustee appointed
by the court for the protection of creditors. Although it is still possible to obtain
a loan after a bankruptcy, a bankruptcy will have a serious impact on your ability
to get a loan and should be discussed with a lender as early in the lending process
as possible.
Buydown: When additional payment is made at closing
for the purpose of reducing the interest rate, whether for a short period or the
full term of the loan.
Commitment: An approval of the mortgage to close at a future date, subject
to the specific terms and conditions that have been agreed upon between lender and
borrower.
Comparables/Comps: Recently sold properties
used in an appraisal to determine the Fair Market Value of the property being appraised. Comparables should be
similar to the subject property in terms of size, location and amenities.
Cost of Funds Index (COFI): An index based on the average cost of obtaining funds for the group of savings
institutions which comprise the index. The most common is the 11th District COFI,
which is the weighted average cost of savings, borrowing and advances for the Federal
Home Loan Bank of San Francisco.
The 11th District COFI is one of the indexes that may be used to set the interest
rate for an adjustable rate mortgage (ARM).
A COFI index usually fluctuates more slowly than other ARM indexes.
Debt to Income Ratio: Actually two
variations on the ratio of a borrower's debt to his income. Considered by a lender
in determining the borrower's ability to repay a loan.
The front end ratio is the borrower's total monthly housing cost (principal, interest,
real estate tax, hazard insurance) divided by total gross monthly income.
The back end ratio is the borrower's total monthly payments (housing cost plus all
monthly payments for auto, credit cards and any other debt) divided by total gross
monthly income.
For example: for an FHA loan the ratios are 29/41. This means that 29% of the borrower's
gross monthly income can go towards housing cost, and 41% of gross monthly income
can go towards his total monthly payments.
Debt to income ratios are very important to the lender in determining your eligibility
for a particular loan. For most sub-prime (imperfect credit) loans, the back end
ratio is the only ratio considered.
Deed: The written document by which ownership of real property is established
or transferred.
Down Payment: The amount of the buyer own
money put in at purchase, not including any closing costs and loan fees. Depending
on such factors as credit standing and the type of loan desired, the buyer may be
required to put down a greater or lesser percentage of the sales price as down payment.
Due on Sale Clause: A clause found in most mortgages, stipulating that
should the borrower sell the property the entire loan amount will come due.
Equity: The owner interest in a property. Market value less all financing.
Fair Market Value: A property's worth
on the open market, assuming a willing buyer and seller with no undue pressure to
act and full knowledge of all significant information relating to the property.
Federal Housing Administration (FHA): Government agency (now a part of
of the Dept. of Housing and Urban Development) created in 1934 to restore lender
confidence and increase home ownership. The FHA does not lend funds, but rather
insures loans that lenders make to consumers. FHA-insured loans can make it much
easier for first-time homebuyers to purchase a home.
Fixed Rate: A mortgage with an interest rate that does not change for
the ter
m of the mortgage. The most popular type of mortgage, except in times of high interest.
Forbearance Agreement: An agreement that the lender will delay exercising
the right to forelose, as long as the borrower performs according to certain conditions.
Foreclosure: To terminate the borrower rights to property after he defaults
on the mortgage loan. Foreclosure proceedings vary by state. Generally the foreclosure
process allows for a redemption period, during which the borrower can attempt to
pay off the debt and reclaim the property.
Gift Letter: Letter verifying that funds given to a borrower are a gift
and need not be repaid.
Good Faith Estimate: Document, required to be given to the borrower at
the time of application, itemizing the costs for the proposed loan.
Gross Income: Total income, before deducting taxes and expenses.
Hazard Insurance: Insurance to protect a property from loss due to fire
and other types of damage. Required in order to get a mortgage.
Impounds: Real Estate Taxes and Insurance as well as Private
Mortgage Insurance (PMI) may be paid apart from the monthly mortgage payment,
or these costs may be added to the principal and interest portion of the mortgage
payment.
Index: An independent, published rate used to set
the interest rate on an adjustable rate mortgage
(ARM). The most common indexes are the 1 year T-bill, the 11th District
COFI, and the LIBOR (London
Interbank Borrowing Rate). The ARM interest rate is determined by adding
a margin to the chosen index.
The different indexes vary in their volatility, and so consumers choice of an index
may depend on the state of interest rates. For example, in times of low rates, a
slow-to-change index may be preferable.
Judgement: The final decree in a court. It can result in a lien being placed on a property.
LIBOR Index: The London Interbank Offered
Rate. It is the index used for Eurodollar deposits traded between banks. A relatively
stable rate, the LIBOR is a popular choice as an index for ARM.
Lien: A claim or encumbrance on a property. Mortgages,
unpaid property tax bills and condo fees are all liens, for example.
Loan to Value Ratio (LTV): The amount of a loan as
a percentage of the value of the property. For example, a loan of 90% LTV on a property
appraised at $100,000 would amount to a mortgage of $90,000. The maximum LTV will
vary between different loan programs.
Margin: The amount that is added to an index to determine the interest rate for an adjustable rate mortgage (ARM). The margin is fixed in the mortgage.
For example, if you have a 2.75 margin on a 1 year T-Bill ARM, you would take the
interest rate of a 1 year T-Bill (for example, 5.75), add on the margin (2.75 +
5.75 = 8.5) and you would have an interest rate of 8.5 percent.
Mortgage: An instrument for lending money on real estate. The property
is pledged as security for the loan, and the lender has the right to take over the
property if the borrower defaults on the terms of the loan. (Mortgage derives
from two French words meaning dead pledge, because when the loan has been
repaid, the mortgage is considered void or dead.
Mortgagee: The lender.
Mortgagor: The borrower.
Owner Occupant: A borrower who will be residing in a property as his/her
principal residence.
Prepayment Clause: A clause in a mortgage, charging a penalty to the
borrower if the loan is paid off before its due date.
Private Mortgage Insurance (PMI): A fee charged by
the lender which is based upon the loan to value of the loan being made. Usually,
this is a fraction of 1% of the loan amount and the fee can be impounded along with
taxes and insurance, or the premium for one year can be paid in full at the close
of the escrow. This fee protects the lender in case of default by the borrower.
FHA loans require Mutual Mortgage Insurance (MMI). Typically once a homeowner has
paid the principal balance of the loan down to below 80% LTV,
the homeowner may request the lender to remove this fee. Some lenders are very picky
about this, and even though the LTV is below 80%, they may keep the PMI on the loan
until it has reached 75% LTV.
Refinance: To pay off an existing mortgage by replacing it with a new
one, usually at a lower interest rate.
Reinstatement: Paying up all delinquent mortgage payments and late charges.
Real Estate Settlement Procedures Act (RESPA): Law requiring lenders
to provide borrowers with information regarding the terms and fees of a mortgage.
Administered by HUD.
Reserves: Funds the borrower
has beyond those necessary to cover the down payment and closing cost. The larger
(and longer held) a borrower's reserves, the better a credit risk he is considered
to be.
Second Mortgage: A mortgage taken on a property which already has a first
mortgage. (Technically, order is determined not by date of signing but by date of
recording in the county records office.) Because a second mortgage is in subordinate
position in the event of default, there is greater risk to the lender, so the interest
rate is generally higher.
Once a mortgage is paid off, any mortgages subordinate to it move up -- a second
becomes a first, a third becomes a second, and so on -- unless a mortgage contains
a subordination clause keeping it in a specified
position.
Steps: The maximum amount that the interest rate
on an adjustable rate mortgage (ARM) can
rise in a single adjustment period.
Subordination Clause: A clause in
a mortgage specifying that it remain in a particular position. For instance, a borrower
may desire to pay off an existing first mortgage and replace it with a new first
mortgage at a lower interest rate. If, however, the borrower also has a second mortgage,
that mortgage will automatically move up to first position unless its holder agrees
to be subordinated to the new mortgage.
Tax Service Fee: A fee paid by the borrower to a service agency, which
monitors the borrower tax payments and notifies the lender if the borrower fails
to pay property taxes. Most mortgages stipulate that the lender may foreclose if
the borrower fails to make tax payments on a timely basis. This is protection for
the lender, as property tax debts supersede any mortgage debts, meaning the lender
may lose his right to foreclose if the county takes over and sells the property
to recover a tax debt.
Term: The length of a mortgage.
Truth in Lending Act (TILA): A federal
law (also known as Regulation Z, which is a part of TILA) ensuring that borrowers
are provided with information on the costs of a mortgage, including the amount financed,
the total finance charges and the annualized percentage rate (APR).
Variable Rate Mortgage: Another name for an adjustable rate mortgage or ARM.
Zoning: Public ordinances which regulate land use.
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