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Adjustable-rate mortgage - A mortgage in which the interest rate is periodically readjusted to a base rate. For example a one-year ARM is reset once a year, on a prescribed date, to the current level of the base rate plus a margin. For one-year ARMs, the base rate is often the one-year U.S. Treasury bill yield, adjusted for a constant maturity.
Adjustment period - Frequency that the interest rate of an adjustable-rate mortgage is repriced to the base rate. For one-year ARMs, the adjustment is made once a year; for three-year ARMs, every three years; etc.
Amortization - Gradual reduction of debt that occurs as periodic payments are applied to loan principal and interest at a rate that repays the loan principal by the end of the loan term.
Amortization tables - Mathematical tables that show how a mortgage or other loan is gradually repaid by applying the appropriate amounts of the loan payment to principal and interest. In the beginning of the repayment period, only a small portion is applied to reducing the loan principal. As the loan approaches maturity, the portion of the payment applied to principal rises.
Annual percentage rate (APR) - The effective interest rate paid on a loan, expressed as an annual rate. APR measures the true interest cost of borrowing by including any fees or prepaid interest involved in obtaining a loan. For instance, if a borrower pays $500 in closing costs to obtain a $10,000 loan, the APR is higher than the simple interest rate because the borrower is repaying a $10,000 loan but only receiving net proceeds of $9,500. The federal Truth-in-Lending Act requires lenders to disclose the APR.
APR (Annual Percentage Rate) - The total cost of the mortgage, expressed as a percentage of the loan amount. Unlike the base interest rate (which only includes interest), the APR includes all costs associated with your loan, including points, origination fees, PMI, etc. Because different lenders charge different fees, the APR is a good way to compare the total cost of a loan from various lenders.
Appraisal value - A mortgage lender determines the fair market value of a home by arranging an independent appraisal of the home's value. The appraisal uses local real estate market sales activity as a major basis for valuation. The appraisal value determines how much the lender is willing to loan. Generally, lenders make mortgage loans of up to 80 percent of the appraisal/fair market value of the home (see loan-to-value (LTV) ratio). For instance, a home appraised at $100,000 can be financed with a first-mortgage loan of $80,000. Before funding a larger percentage of the appraisal value, lenders generally require that borrowers obtain private mortgage insurance (PMI), which protects the lender from default.
Appreciation rate - Percentage increase in the value of an asset, expressed at an annual rate. A home bought for $100,000 that appreciates five percent a year will be worth $127,600 after five years.
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Base rate - The underlying interest rate used as a benchmark, or index, for pricing variable-rate loans such as adjustable-rate mortgages, auto loans or credit cards.
Buy-down - A mortgage subsidy that is sometimes offered by a homebuilder to help buyers afford the property. The builder pays a portion of the interest payment for a few months (or sometimes a few years), thereby lowering the initial monthly payment for the buyer.
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Closing costs - Charges associated with the underwriting and funding of a loan that are paid when the loan is about to be disbursed and the borrower about to take possession of the asset. Mortgage closing costs include title search, appraisal fee, legal and escrow service fees, and mortgage points.
COST ANALYSIS - A cost-benefit analysis that subtracts homeownership benefits from homeownership costs. Included in the calculation of homeownership costs are:
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Mortgage interest, including points
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Closing costs
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Property taxes and homeowner's insurance
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Private mortgage insurance (PMI)
Included in benefits are:
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Tax shield received from mortgage interest and points
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Tax shield received from property taxes
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Appreciation in value of your home due to market conditions (an increase in equity)
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Loan principal repayment (an increase in equity)
CLOSE OF ESCROW - The end of the Escrow Period, or the date that a homebuyer takes possession of their new home. At the close of escrow, the Escrow Company prepares several documents which are signed by the builder and the buyer. The Escrow Company then makes all final payments to the builder, and the homebuyer receives the keys to their brand new home.
CLOSING COSTS - All upfront fees and charges related to the home purchase, excluding the down payment. Closing costs may include points or other origination fees, any pre-paid interest, pro-rated property taxes (if any), etc. For most loans, the closing costs are paid by the buyer at the close of escrow.
CREDIT REPORT - A report from an independent credit rating service (such as TRW or Equifax) listing all of your current obligations to various creditors, including credit card companies, car payments, student loans, etc. The report shows how much is owed, as well as whether your payments are generally on time. A credit report is a required document when applying for a home loan.
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DEED OF TRUST - The document that pledges the subject property as collateral for the repayment of the loan.
DEPOSIT/EARNED MONEY - Money paid by the buyer in "good faith" to assure performance of contract.
DOWN PAYMENT - The portion of the purchase price which a buyer pays before moving in. Often, the down payment is expressed as a percentage of the total purchase price, typically between 3% and 20%. If you have never owned a home before, your down payment often comes from personal savings, an employer-sponsored 401K program, or other source. If you are selling one home in order to buy another, then your down payment usually comes from the equity in your current home. In addition to the down payment, there are usually other costs and fees called closing costs which a buyer needs to pay before moving in.
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EQUITY - Difference in the market value of a home and the total amount of debt or other encumbrances used to pay for the home. As market value increases and the borrower repays the mortgage loan, equity increases.
EQUITY - The portion of a home’s total current value that is "owned" by the homeowner. To calculate the amount of equity you have in your home, take the current value and subtract the amount still outstanding on your mortgage loan.
ESCROW PERIOD - The period between the time you sign a purchase contract and you actually take possession of the home. During this period, a buyer deposits a series of payments to a neutral third party (called the Escrow Company), covering the down payment and closing costs. At the end of the process, the Escrow Company gives the payments to the builder, and the buyer gets possession of the house. Depending on circumstances, this process typically takes from one week to 45 days.
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FHA MORTGAGE - A mortgage that is insured by the Federal Housing Administration which offers low rate, low down payment mortgages to buyers (terms vary county by county).
FIXED-RATE MORTGAGE - A mortgage in which the interest rate (and therefore the monthly payment) remains the same for the entire life of the loan. 30-year and 15-year fixed rate mortgages are industry standards. Many homebuyers prefer a fixed-rate loan because the payment amount never changes.
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GOOD-FAITH ESTIMATE - A line item estimate from a lender of total closing costs.
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HOMEOWNER'S INSURANCE - Insurance coverage required by a mortgage lender to insure against such potentially catastrophic damage to a home (the lender's collateral) as flood, fire, tornado, or hurricane. Homeowner's insurance also provides liability coverage in case someone is injured on your property.
HOMEOWNER'S INSURANCE - Insurance including hazard coverage that insures for damages that may affect the value of a house, in addition to personal liability and theft coverage.
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IMPOUNDS FOR TAXES AND INSURANCE - Typically, a monthly mortgage payment has four components: principal, interest, taxes and insurance ("PITI"). The taxes and insurance portions represent property taxes and homeowner's insurance premium, respectively. These are often required by the lender to be included in a monthly payment since regular and timely payment of both of these obligations improves the lender's collateral position.
INDEX - An index is the benchmark interest rate used by lenders to price loans. For residential mortgage lending in the U.S., 10-year U.S. Treasuries are often used for 30-year mortgage loans (on average, most homeowners live in their homes for a period of time closer to 10 years than 30 years). For adjustable-rate mortgage loans, the two most common indexes are the one-year, constant maturity-adjusted Treasury bill and the Eleventh District Cost of Funds Index (COFI), published by the Federal Home Loan Bank of San Francisco, a federally chartered thrift institution.
INITIAL RATE - The starting interest rate on an adjustable-rate mortgage loan, which is often below market ARM rates. The intent of a low initial rate is to assist homebuyers that may not otherwise qualify for a mortgage loan.
INTEREST-ONLY MORTGAGE PAYMENTS - Mortgage payments that include only interest. No loan amortization occurs and, thus, the homeowner does not accrue any equity (unless the home value increases).
INTEREST RATE CAP - A limit on the amount the interest rate can increase. A periodic cap limits how much the rate can increase at each adjustment period. A lifetime cap limits how much the rate can increase during the term of the loan.
IMPOUND ACCOUNT - Depending on the type of the loan, some lenders increase the size of the monthly payment to cover important bills such as property taxes and insurance. This extra amount is deposited into an interest-earning Impound Account. At the end of the year, when the taxes or insurance premiums are due, the lender automatically pays the bill from the buyer’s account.
INTEREST - The amount that is added onto your loan (in dollars) to cover the cost of borrowing money to finance your home. The "interest payment" is the portion of your monthly payment that is applied against the interest owed. At the beginning of your loan period, the majority of your monthly payment is applied against the interest. But over time, more and more of the payment is used to reduce the amount of principal owed.
For most people, a portion of their annual mortgage interest payment is tax-deductible. Consult your tax advisor for details.
INTEREST RATE - The cost of borrowing, expressed as an annual percentage of the principal. Many factors influence the interest rate you will be charged, including the overall state of the economy, the cost the lender is charged to borrow the funds, etc.
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LOAN QUALIFICATION ESTIMATES: AGGRESSIVE VS. CONSERVATIVE - Lenders relax their underwriting guidelines when economic times are good and competition for borrowers increases. This is considered an aggressive loan-making position. At other times-such as when there are layoffs or an economic slowdown-lenders will tighten their underwriting guidelines to make it more difficult to qualify for a loan. This is considered a conservative loan-making position. If a lender is aggressively seeking loans, he or she is likely to make it easier to qualify for a loan. If a lender wants to make only the most conservative loans, he or she is likely to make qualification more difficult.
LOAN-TO-VALUE (LTV) Ratio - The ratio of the amount of money owed on a home to the home’s value. The difference between these two figures initially is the down payment.
MARGIN - The amount a lender adds to the base rate of an adjustable-rate mortgage to determine the loan rate. For instance, if a one-year ARM is priced at a margin of 300 basis points (100 basis points is equal to one percent) over the yield on the one-year constant maturity-adjusted Treasury bill, and the T-bill's yield is 6.5 percent, the one-year ARM rate would be 9.5 percent.
MORTGAGE POINTS - One mortgage point equals one percent of the loan amount (e.g., $1,000 on a mortgage loan of $100,000). Mortgage points are also called discount points. The IRS considers points to be a form of prepaid interest which means they can be deducted from taxable income. Lenders often require that the borrower pay one or two points at closing in exchange for a lower mortgage rate (the lender's target APR remains the same).
MORTGAGE - A loan used for the purchase of a new home. Mortgages are available from banks, savings & loans, credit unions, mortgage companies, etc.
MORTGAGE ANALYSIS - A calculation of how much home you can afford, based on your income, your current credit obligations, etc.
NEGATIVE AMORTIZATION - The opposite of amortization. In the case of an adjustable-rate mortgage with a payment cap, a upward adjustment in the interest rate may cause the loan payment to be insufficient to cover even the interest portion of the scheduled payment. In this case, the unpaid interest is added to the mortgage loan principal (if the loan agreement permits) and the loan amount increases.
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ORIGINATION FEE - A loan fee, often as much as one percent of the loan amount, paid to the lender for processing and originating a loan.
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PAYMENT CAP - A limit on the amount that the monthly payment can increase. A periodic cap limits the amount of the increase at each adjustment period. A lifetime cap limits the amount that the monthly payment can increase during the term of the loan. A potential peril of payment caps is negative amortization. In the case of an adjustable-rate mortgage with a payment cap, rising interest rates may cause the loan payment to be insufficient to cover even the interest portion of the scheduled payment. In this case, the unpaid interest may be added to the mortgage loan principal, if the loan agreement permits.
PREPAID INTEREST - See mortgage points.
PRIVATE MORTGAGE INSURANCE (PMI) - Paid by a borrower to protect the lender in case of default. PMI is typically charged to the borrower when the loan-to-value (LTV) ratio is greater than 80 percent. The Homeowners Protection Act of 1998 mandates that a lender notify a borrower when the LTV falls below 80 percent, at which time a borrower is allowed to cancel the PMI coverage.
PROPERTY TAXES - Levies assessed on real property. A local assessor can provide information on tax rates.
PITI (PRINCIPAL, INTEREST, TAXES AND INSURANCE) - The total amount of your monthly payment. Principal and interest (P&I) are due on every loan. Taxes and insurance (T&I) are also included if the lender requires an impound account.
PMI (PRIVATE MORTGAGE INSURANCE) - Insurance purchased by the lender to protect them in case a buyer cannot make their loan payments. PMI typically costs between $50 and $200 per month, depending on the size of the mortgage. This monthly amount is paid by the homebuyer, as part of their monthly mortgage payment. Buyers can avoid a PMI payment if their down payment is large enough (typically 20% of the home price).
POINTS - An upfront fee charged by a lender to process a mortgage. Each point represents 1% of the loan amount. So a $120,000 loan "with one point" means a fee of $1,200. For most (but not all) loans, the points must be paid at the close of escrow, and cannot be added to the amount of the loan.
PRE-QUALIFICATION - Another name for a Mortgage Analysis.
PRINCIPAL - The amount of your loan (in dollars), excluding interest. The "principal payment" is the portion of your monthly payment that is applied against the principal. In the first several years of your loan, only a small amount of the payment is applied to the principal. As time goes on, more and more of the payment is used to reduce the amount of principal
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SAVINGS RATE - The interest rate expected on the most conservative of investments. A conservative estimate should be used if the money is intended to be invested for a short time only or the investor is unwilling to risk losing any of the investment. A money market rate of between 5.5 and 6.5 percent is a conservative rate (as of June 2000).
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TAX RATES - The five federal income tax rates range from 15 percent to 39.6 percent. To determine the applicable income tax rate, see the IRS' tax rate schedules (if adjusted gross income is $100,000 or more) and tax tables (for AGI under $100,000). Several states, including Washington, Alaska, and Wyoming, do not levy income taxes.
TAX SAVINGS - The amount saved on taxes by itemizing deductions on income tax returns (FinanCenter.com calculators assume deductions are itemized if they exceed standard deductions). Mortgage interest and property taxes are tax-deductible, and therefore generate a tax shield benefit.
TAX SHIELD - The amount saved in taxes by taking deductions. To measure the tax shield benefit, multiply the amount of the deduction by your tax rate. For instance, if an investor deducts $1,000 in mortgage interest expense and is in the 28 percent income tax bracket, she enjoys a tax shield benefit of $280.
TERM - Period of loan, expressed in years. Residential mortgage loans typically are made for 15- or 30-year terms.
TITLE COMPANY - Firm that ensures that the title, or actual legal document of ownership, on a property is clear and provides title insurance.
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VA LOAN - VA loans are available to active members of the armed forces, as well as to veterans and unremarried surviving widows of veterans. VA loans are backed by the Veterans Administration, which offers several benefits to buyers:
No down payment required
Lower closing costs
VARIABLE INTEREST RATE LOAN - Another name for an Adjustable Rate Mortgage (ARM).
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