To ensure that you have complete confidence during your home loan process, invest a moment to read this report and become familiar with the most common terms you will encounter. When you hear terms that are not on this list (a full list would be long and cumbersome), give yourself permission to ask questions until you fully understand the terms. The more you know and understand, the more educated and successful your decisions will be.
Adjustable Rate Mortgage
A mortgage on which the interest rate is adjusted based on a pre-selected time frame and a pre-selected index. For example, consider a 7/1 Fixed-ARM at 6.50% with 5/2/5 caps and a margin of 2.25% over the LIBOR index. The easiest way to understand this is to break it down to the individual pieces:
7/1: The "7" means the initial interest rate is fixed for seven (7) years. The "1" means the interest rate adjusts once (1) per year thereafter.
6.50%: This is the interest rate that is fixed for the first seven (7) years
5/2/5 caps: The caps set the maximum interest rate for the specific adjustment periods during the loan. The caps are listed in the following order: Initial rate cap / Annual rate cap / Lifetime rate cap. These caps set the maximum rate, the actual rate at the time of each adjustment is determined by the Index + Margin.
Initial rate cap = 5%. The interest rate can increase a maximum of 5% over the initial interest rate when the mortgage first adjusts after the seven year fixed period.
Annual rate cap = 2%. The interest rate can increase a maximum of 2% over the current rate each time the mortgage adjusts.
Lifetime rate cap = 5%. The interest rate can increase a maximum of 5% over the lifetime of the loan.
Margin of 2.25%: The interest rate at the time of each adjustment is calculated by adding this Margin to a pre-selected Index. For example, if the LIBOR index is 5.25% at the time of adjustment, the new interest rate will be 7.50% which is determined by adding the Index rate 5.25% + Margin 2.25% = 7.50%.
LIBOR index: The index is an independent financial benchmark which is used as the basis for the adjusting mortgage. The LIBOR index is the London Interbank Offered Rate but there are several other commonly used for adjustable rate mortgages. It is important to know the specific index on which the mortgage will adjust because each has different attributes that could impact your future.
Annual Percentage Rate (APR):
The Annual Percentage Rate reflects the costs of the mortgage as a yearly rate. This rate takes in to account Points and fees (closing costs) and is based on the loan going to its full term. Unfortunately, the APR is often inaccurate for Adjustable Rate Mortgages and can easily be manipulated by lenders. For more information on this topic, read What You Don't Know About APR Can Cost You.
Closing / Close of Escrow / Settlement:
The meeting at the conclusion of the real estate transaction where the buyer and seller sign the legal documents and funds are exchanged.
Closing Costs:
The total points and fees that are associated with purchasing a home and obtaining a mortgage. Often, a good negotiation strategy is to have the seller pay the Closing Costs on your behalf so your funds can be devoted entirely to your down payment and your equity in the home.
Debt-to-Income ratio:
This ratio, expressed as a percentage, results from adding the new house payment plus the monthly payments on all other credit accounts and dividing it by your gross income.
Down Payment:
The difference between the Purchase Price and the mortgage. The total cost to purchase a home will be the Down Payment plus the Closing Costs.
Earnest Money:
Money paid at the time your Purchase Offer is written to prove your commitment to follow through on the transaction. The funds paid for Earnest Money apply toward the funds due at closing but could be forfeited to the seller if you choose to back out of the transaction without cause.
Escrow / Impound account:
The term "Escrow" is commonly used for two different topics which often causes confusion. The first use of the term "Escrow" is in reference to the Escrow Company which is the neutral third-party who handles the final preparation of the legal documents for Closing and disburses the funds to the appropriate parties. The second use of the term "escrow" refers to an Escrow or Impound account. The Escrow/Impound account is a separate account that holds the money for your property taxes and home owner's insurance that is collected with your monthly payment.
Fixed Rate Mortgage:
A mortgage in which the interest rate is fixed and constant for the entire life of the loan.
Good Faith Estimate:
A form which lists all the costs associated with a purchase or refinance including Down payment, Origination fee, Discount Points, credit report, appraisal, Tax Service Fee, Title Insurance, Escrow Settlement charges, Property Taxes, Homeowner's insurance, etc. This form should reflectallcosts associated with the transaction and should closely match the final HUD-1 Settlement Statement that you receive at the close of your transaction.
HUD-1 Settlement Statement:
This is the final accounting form that you sign at the close of your purchase or refinance which specifically lists the final costs for every item associated with your transaction. This should closely match the Good Faith Estimate you received at loan application, however, Federal Lending law allows a significant variance (a $6,250 discrepancy on a $500,000 loan) before requiring that the discrepancy be disclosed prior to closing.
Loan-to-Value ratio:
The ratio, expressed as a percentage, of the mortgage loan compared to the value of the property. If your mortgage financing includes two mortgages (a first and a second mortgage), the ratio is expressed as Combined-Loan-to-Value.
Negative Amortization / Deferred Interest:
Negative Amortization or Deferred Interest results when the required minimum payment doesn't cover the actual cost of interest. The difference between the actual interest cost and the payment is then added to the mortgage, resulting in an increasing mortgage balance.
Origination Fee:
A fee charged by the lender for processing the loan application. This is usually computed as a percentage of the loan amount.
Permanent Buydown:
Paying Points to permanently lower the interest rate. Points may be paid by the buyer or by the seller on behalf of the buyer (negotiable).
PITI:
The acronym used to describe the total monthly housing cost and refers to Principal, Interest, Taxes and Insurance.
Points:
The cost to buy a lower interest rate. One Point is equal to 1 percent (1%) of the loan amount (on a $500,000 mortgage, 1 Point = $5,000)
Prepayment Penalty:
A monetary penalty for paying off a mortgage within a specified time frame in exchange for a lower interest rate. There are two common types of prepayment penalties: A "hard" prepayment penalty means the penalty must be paid if you refinance OR sell the home. A "soft" prepayment penalty allows you to sell the home (in an arms-length transaction to a non-family member) with no penalty but you will incur the penalty if you refinance.
Private Mortgage Insurance:
Insurance that protects the lender against loss if a borrower defaults. Private Mortgage Insurance (PMI) is required if the first mortgage exceeds 80% of the property value. PMI is not tax deductible and is normally added to your monthly payment. Strategies to finance more than 80% without incurring PMI include "Piggyback" mortgages (2nd loans or Home Equity Lines of Credit) or Lender Paid Mortgage Insurance.
Temporary Buydown:
The lender, seller or homebuilder lower the buyer's monthly house payment for a short period of time.
Underwriting:
The decision-making process of reviewing a mortgage application and approving a loan for a potential home buyer.