This brief glossary will help you understand some of the more common terms used during the application, selection, processing, and closing of your mortgage loan.
Adjustable Rate Mortgages
An adjustable rate mortgage (ARM) usually has a lower initial interest rate than for fixed-rate mortgages, then adjusts after a specified period. A homebuyer may be able to qualify for a larger loan amount under an ARM program than with a fixed rate program.
The rate for your ARM is based on the index rate (see "Index Rate";) and can go up or down, depending on what the index rate is doing. Simply put, you obtain a lower rate with an ARM in exchange for assuming the risk that your payments may increase. The terms that follow will help you understand some of the important ARM concepts.
There are several types of ARMs available. The most common have one-year, three-year and five-year adjustment periods. These refer to the period between one rate change and the next. A loan, for example, with an adjustment period of one year is called a one-year ARM. This means the interest rate can change once every year.
Most lenders tie ARM interest rate changes to changes in an "index rate." These indexes usually go up and down with the general movement of interest rates. In most circumstances, your mortgage rate and payment go up if the index rate rises. On the other hand, if the index rate goes down your rate and monthly payment may also. Lenders base ARM rates on a variety of indexes. You should ask your lender what index will be used and how often it changes. Also ask how it has behaved in the past and where it is published.
To determine your ARM rate, lenders usually charge a few percentage points over the Index Rate. Margin is the difference between the Index Rate and your ARM rate. Margins can differ from one lender to another, but are usually constant over the life of the loan. Be sure to discuss the margin with your lender.
Interest Rate Caps
This is a limit on the amount your interest rate can increase. There are two different types of Interest Rate Caps:
Periodic caps, which limit the interest rate increase from one adjustment period to the next.
Overall caps, which limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have an overall cap.
By law, virtually all ARMs must have an overall cap.
This is the limit a monthly payment can increase at the time of each adjustment, usually to a percentage of the previous payment. In other words, with a 7.5% payment cap, a payment of $100 could increase to no more than $107.50 in the first adjustment period, and to no more than $115.56 in the second.
This can happen when a Payment Cap prevents a monthly mortgage payment from covering the interest due. If your ARM allows for negative amortization, the interest shortage in your payment will be automatically added to your debt, and you may owe the lender more than you did at the start.
The amortization tables allow you to see a summary of unpaid principal, interest paid and initial monthly payment for each year of the life your loan.
The appraised value is the market price of the home you wish to buy. In some cases you may pay more or less than the appraised value of the home. But you can generally assume that the appraised value of the home is also the purchase price. This figure is used to determine your down payment and whether or not you'll be required to pay mortgage insurance.
Annual Percentage Rate (APR)
The APR is required to be disclosed to you by the lender under the federal Truth in Lending Act, Regulation Z. APR is usually higher than the interest rate shown for the mortgage note because it includes up-front costs paid to obtain the loan. The APR does not include title insurance, appraisal, and credit report. Ask your lender for more information.
Typically the market value of your home will increase over time. The appreciation rate is a way to judge how quickly the home's value is increasing. You can estimate this figure by calculating the percent increase of the home's value over a period of one year. For example, suppose that you own a $100,000 home and that the value of your home increases by roughly $3,000 per year. In this case, the home's appreciation rate would be 3% because the home's value has grown by 3%, from $100,000 to $103,000.
Costs are the appraisal fees, underwriting or other lender fees, title insurance, and escrow fees. Closing costs can sometimes differ between lenders.
A Cost Analysis helps a lender determine how to choose the mortgage option that will cost you the least over the period you own your home. For total costs, lenders usually calculate the following:
The interest you pay
The discount points you pay
The closing costs you pay
The property tax and property insurance you pay
The mortgage insurance you pay
Lenders also take these benefits into consideration:
The tax savings you receive from paying interest and discount points
The tax savings you receive from paying property taxes
The appreciation (increase in the home's value) you gain
The amount of principal you repay with each payment
One discount point is equal to 1% of your loan amount. In other words, one discount point on a $100,000 mortgage loan equals $1,000. Discount points are paid to obtain a lower interest rate on your mortgage. The more points you pay, the lower the rate.
This is the difference between what you owe on your mortgage loan and the appraised value of the home. Your equity increases if your home goes up in value, and also when you pay on your principal each month.
To obtain a mortgage, homeowner’s insurance is required based on the value and contents of your home. Your lender or real estate agent may be able to help you estimate typical payments in your area.
Tax and Insurance Impounds
One month's worth of your yearly tax bill and your yearly homeowner's insurance premium will be added to your loan payments.
Here's why taxes and insurance are collected along with your principal and interest payments:
If your taxes are left unpaid, your state can foreclose on your property in order to obtain payment. If the foreclosure is successful, the lender could lose his collateral. In other words, if you're not making your payments, the lender could not recoup his loss: the state's foreclosure would supercede his.
The lender also wants to make sure your insurance premium is always paid. If your property is destroyed by a fire, he'll have lost his collateral, but his loan should be repaid by the insurance company.
This is typically for people who want to maximize how much they can borrow. With this type of loan, however, you do not build any equity in the home and will need to make larger monthly payments to pay back the principal.
Loan To Value (LTV)
In most cases, a home is worth more than the mortgage balance. In other words, the mortgage balance is a percentage of what the home is actually worth. The percentage represents the Loan To Value. For example, if a home is worth $100,000 and the mortgage owed is $80,000, the LTV is 80%.
Mortgage insurance, commonly called “Private Mortgage Insurance” (PMI), protects the lender from loss if you stop making payments. All lenders require this, however, you may not have to pay mortgage insurance if your down payment is more than 20% of the appraised value of your home. Check with your lender to see how your mortgage insurance can be waived.
This fee is usually 1% of the loan amount and pays the lender for processing and originating your loan. As an example, the origination fee on a $100,000 mortgage loan is $1,000.
Paid at closing, this is the amount of interest – usually calculated daily – that you owe from the day your loan closes to the end of the month. For example, if you close on January 15 and your interest is $21 per day, you would pay interest through January 31 ($21 X 16). After that, when you make your monthly mortgage payment, interest is always paid for the previous month. So you would not make your first payment until March 1, which pays principal and interest for the month of February.
Property taxes are different for each county and is usually a straight percentage of your property's value. Your lender will collect at least one month of property taxes at your closing to set up an account so that they can pay your taxes when they are due. In some cases you can pay your taxes annually, but usually pay them monthly. The monthly amount you pay is added to this account, sometimes called "impound" or "escrow". If you need help estimating your yearly property taxes, please contact your county assessor's office.
Aggressive vs. Conservative Qualification Estimate
Lenders consider a number of things such as your credit history when deciding how much they are willing to lend you. Based mostly on income, debt and credit history, lenders figure this two ways: Aggressive, for individuals whose circumstances are favorable, and Conservative for individuals whose situation could cause the lender to be more cautious.
Savings rate refers to the annual amount of interest you can earn on money you save. This rate is generally used to compare two loan options. For example, if you decide to make a larger down payment on your home, you are sacrificing the interest you would have earned on the additional amount of money.
In some home financing calculators, you are asked to make a comparison between two financing options. If one of the options costs more than another, the difference is invested into a savings account because you've saved money with that option. To make a fair comparison, the calculator tracks the balance and interest earnings on this account. As earnings in this account grow, they are taxed at the rate you indicated. Your personal tax rate is also used to compute your tax savings. To estimate your tax rate, divide the amount you paid in taxes last year by your income. If prompted, please include federal and state taxes.
Most people can take a Standard Deduction on their tax return, which is an amount the IRS allows you to deduct from your taxable income. However, you can usually deduct your mortgage interest, home equity loan interest (if you have one), property taxes and points you pay at closing by itemizing your deductions. You can also itemize other expenses, such as charitable contributions. If the total of these amounts is higher than your Standard Deduction, you can save more in taxes each year.
The following charts show Standard Deductions allowed, who qualifies and an example of how itemizing can reduce the amount of taxes paid.
The length of time that you will make payments on your loan. Typical mortgages have terms of 15, 30 or 40 years. The shorter the term, the lower the interest rate. Ask your lender which term is best for you