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 HELPFUL REAL ESTATE TERMINOLOGY

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 re-priced 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 in reducing the loan principal.  As the loan approaches maturity, the portion of the payment applied to principal increases.

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.

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.

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.

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 is 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:

·        Mortgage interest, including points

·        Closing costs

·        Property taxes and homeowner's insurance

·        Private mortgage insurance (PMI)

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.

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.

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. Treasury’s 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 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.

Loan-to-value (LTV) ratio

Loan amount divided by the fair market value of the collateral, generally the appraisal value.  For instance, a lender considering an 80 percent LTV on a home appraised at $250,000 would consider a loan request of $200,000. 

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).

Negative amortization

The opposite of amortization.  In the case of an adjustable-rate mortgage with a payment cap, an 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.

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.

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

Per day interest charged from the date of funding through the end of the month.

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.

Term

Period of loan, expressed in years.  Residential mortgage loans typically are made for 15 or 30-year terms.