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
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
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
Cost of Funds IndexCOFI: 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
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
m of the mortgage. The most popular type of mortgage, except in times of high
Forbearance Agreement: An agreement that the lender will delay
the right to forelose, as long as the borrower performs according to certain
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
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
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
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.