Mortgage Terms Worth Knowing
If you are starting the process of buying a home, or even if you already own a home and are considering the status of your current loan, here is a list of mortgage terms worth knowing.
ARM (Adjustable-Rate Mortgage): a mortgage loan subject to changes in interest rates (see Fixed-Rate Mortgage). When rates change, ARM monthly payments increase or decrease at intervals determined by the lender; the change in monthly payment amount, however, is usually subject to a cap.
Amortization: a Payment plan that enables you to reduce your debt gradually through set monthly payments. The payments may be principal and interest or interest-only. The monthly amount is based on the schedule for the entire term (length) of the loan.
Annual Percentage Rate (APR): a Measure of the cost of credit, expressed as a yearly rate. It includes interest as well as other charges. Because all lenders, by federal law, follow the same rules to ensure the accuracy of the annual percentage rate, the APR provides consumers with a good basis for comparing the cost of loans, including mortgage plans. APR is a higher rate than the simple interest on the mortgage.
Assessed Value: The value that a public official has placed on any asset (used to determine taxes).
Assumable Mortgage: When a home is sold, the seller may be able to transfer the mortgage to the new buyer. This means the mortgage is assumable. Lenders generally require a credit review of the new borrower and may charge a fee for the assumption. Some mortgages contain a due-on-sale clause, which means that the mortgage may not be transferable to a new buyer. Instead, the lender may make you pay the entire balance due when you sell the home. An assumable mortgage can help you attract buyers if you’re selling your home.
Building Code: Based on agreed upon safety standards in a specific city or county but including all applicable state and federal statutes, a building code is a set of regulations that determines the design, construction, and materials used in building.
Buy-Down: The seller pays a sum to the lender so that the lender will provide a lower rate and lower payments to the buyer; this is often done for an ARM. The seller may increase the sale price to cover the cost of the buy-down.
Capital Gain: The profit received based on the difference between the original purchase price and the total sale price.
Clear Title: a property title that has no defects. Properties with clear titles are marketable for sale. When a title is not clear—that is, if there is any ambiguity or confusion about who holds it—the title is said to be clouded.
Closing: The final step in property purchase whereby the title is transferred from the seller to the buyer. Closing occurs at a meeting between the buyer, seller, the settlement agent, and other agents. At the closing, the seller receives payment for the property. Also known as settlement.
Closing Costs: fees for final property transfer not included in the price of the property. Typical closing costs include charges for the mortgage loan such as origination fees, discount points, appraisal fee, survey, title insurance, legal fees, real estate professional fees, prepayment of taxes and insurance, and real estate transfer taxes. A common estimate of a buyer’s closing costs is two to four percent of the purchase price of the home. A common estimate for seller’s closing costs is three to nine percent of the price.
Comparative Market Analysis (CMA): also commonly called “comps”—an evaluation that determines approximate property value (or fair market value) by comparing similar properties sold within the last year.
Contingency: a clause in a purchase contract outlining conditions that must be fulfilled before the contract is executed. Both buyer or seller may include contingencies in a contract, but both parties must accept the contingency.
Counter–Offer: a rejection of all or part of a purchase offer that proposes a different term or terms in order to reach an acceptable sale contract.
Debt-to-Income Ratio: a comparison or ratio of gross income to housing and non-housing expenses. The FHA (Federal Housing Administration, which insures mortgage loans in order to facilitate lending to home buyers) requires that the monthly mortgage payment should be no more than 29% of monthly gross income and that the mortgage payment combined with non-housing debts should not exceed 41% of income.
Disclosure: The release of relevant information about a property that may influence the final sale, especially if it represents defects or problems. “Full disclosure” usually refers to the responsibility of the seller to voluntarily provide all known information about the property. Some disclosures may be required by law, such as the federal requirement to warn of potential lead-based paint hazards in pre-1978 housing. A seller found to have knowingly lied about a defect may face legal penalties.
Discount Point: Normally paid at closing and generally calculated to be equivalent to 1% of the total loan amount, discount points are paid to reduce the interest rate on a loan. In an ARM with an initial rate discount, the lender gives up a number of percentage points in interest to give the borrower a lower rate and lower payments for part of the mortgage term (usually for one year or less). After the discount period, the ARM rate will probably go up, depending on the index rate.
Down Payment: The portion of a home’s purchase price that is paid in cash and is not part of the mortgage loan. This amount varies based on the loan type, but is determined by taking the difference between the sale price and the actual mortgage loan amount. Mortgage insurance is required when a down payment of less than 20 percent is made.
Equity: An owner’s financial interest in a property; calculated by subtracting the amount still owed on the mortgage loan(s)from the fair market value of the property.
Escrow: Funds held in an account to be used by the lender to pay for home insurance and property taxes. The funds may also be held by a third party until contractual conditions are met and then paid out on closing.
FICO Score: FICO is an abbreviation for Fair Isaac Corporation and refers to a person’s credit score based on credit history. Lenders and credit card companies use the number to decide whether the person is likely to pay his or her bills. A credit score is arrived at using information from the three major credit bureaus and is usually between 300 and 850.
Fixed-Rate Mortgage: a mortgage with payments that remain the same throughout the life of the loan because the interest rate and other terms are contractually fixed and do not change.
Loan Origination Fee: a charge by the lender to cover the administrative costs of making the mortgage. This charge is paid at the closing and varies with the lender and type of loan. A loan origination fee of one to two percent of the mortgage amount is common.
Loan to Value (LTV) Ratio: a percentage calculated by dividing the amount borrowed by the price or appraised value of the home to be purchased; the higher the LTV, the less cash a borrower is required to pay as down payment.
Mortgage Insurance: a policy, paid for by the borrower, that protects lenders against some or most of the losses that can occur when a borrower defaults on a mortgage loan. Mortgage insurance is required primarily for borrowers with a down payment of less than 20% of the home’s purchase price. The cost of mortgage insurance is usually added to the monthly payment. Mortgage insurance is maintained on conventional loans until the outstanding amount of the loan is less than 80 percent of the value of the house or for a set period of time (7 years is common). Mortgage insurance is available through a government agency such as the Federal Housing Administration (FHA) or through insurance companies (in which case it is known as private mortgage insurance or PMI).
Multiple Listing Service (MLS): An MLS is a service of the local Board of Realtors within any given area whose function is to ensure that all properties on the market (listed properties) in the area are known to the member realtors. Realtors submit listings and agree to attempt to sell all properties in the MLS. Each local MLS has a protocol for updating listings and sharing commissions. The MLS offers the advantage of more timely information, availability, and access to houses and other types of property on the market.
Offer: Indication by a potential buyer of a willingness to purchase a home at a specific price; generally put forth in writing.
PITI (Principal, Interest, Taxes, and Insurance): The four elements of a monthly mortgage payment; payments of principal and interest go directly towards repaying the loan, while the portion that covers taxes and insurance (homeowner’s and mortgage, if applicable) goes into an escrow account to cover the fees when they are due.
Pre-Approval: a lender commits to lend to a potential borrower a fixed loan amount based on a completed loan application, credit reports, and disclosure of debt and savings, all of which have been reviewed by an underwriter. The commitment remains as long as the borrower still meets the qualification requirements at the time of purchase. However, pre-approval does not guarantee a loan until the property has passed inspections according to the underwriting guidelines.
Prepayment Penalty: a fee charged to a homeowner who pays one or more monthly payments before the due date. It can also apply to principal reduction payments.
RESPA: Real Estate Settlement Procedures Act—a law protecting consumers from abuses during the residential real estate purchase and loan process by requiring lenders to disclose all settlement costs, practices, and relationships.
Underwriting: The process of analyzing a loan application to determine the amount of risk involved in making the loan. It includes a review of the potential borrower’s credit history and a judgment of the property value.
Special thanks to U.S. Department of Housing and Urban Development for some of the definitions above.