Glossary of Terms

Adjustable Rate Mortgage: A mortgage loan were the interest rate adjusts periodically based on the changes of a specified index such as the one-year Treasury Bill or the LIBOR.

Amortization: The calculation of the amount of the installment payment it takes to pay off the obligation at the end of a fixed period of time.

Annual Percentage Rate (APR): The total cost of a mortgage stated as a yearly rate. It is typically higher than the note rate because it includes the base interest rate plus specific closing costs.

Appraisal: A professional report that estimates the market value of a property.

Assessed Value: The value a tax authority places on real property for the purpose of assessing yearly property taxes.

Balloon Mortgage: A mortgage that is amortized over a stated period but provides for a lump-sum payment due at an earlier period, e.g. 30-year due in 15, where the payments are based on 30-year repayment but the loan is due paid in full in 15 years.

Cap: Limits how much the interest rate on an adjustable rate mortgage (ARM) can increase or decrease.

Cash to Close: Liquid assets available to be used to pay the closing costs involved with a mortgage transaction.

Collateral Property: pledged as security for a loan, such as property pledged as security for a mortgage.

Conventional Mortgage: A mortgage not obtained under a government-insured program.

Deed: A legal document that is recorded in the county conveying title to a property.

Deed of Trust: The legal document that pledges the property for the security of a mortgage loan.

Default: Failure to make mortgage payments in a timely manner or to comply with other requirements outlined in the note.

Earnest Money Agreement (Sales Contract): The written agreement between the buyer and seller of a property, which stipulates the amount of the purchase, closing date and any repairs or other conditions that must be met before the transaction (purchase) is completed.

Easement: A right of way given to persons other than the owner for access to or over their property.

Equity: The portion of a property's value over and above the amount owed against it.

Escrow: A disinterested third party that handles legal documents and funds on behalf of the seller and buyer.

First Mortgage: A real estate loan that has priority over any other subsequently recorded mortgages.

Fixed Interest Rates: An interest rate which does not change during the term of the loan.

Foreclosure: A legal procedure in which the mortgage loan is in default and the property taken from the borrower and sold by the lender to pay off the loan against the property.

Gift Letter: A written letter signed by the individual giving funds for the purpose of buying a home which states there is no obligation to repay the sum of money being given.

Gross Monthly Income Total monthly income earned before taxes or other deductions.

Hazard Insurance: Also referred to as homeowners or fire insurance; coverage for physical damage to a property from fire, wind, vandalism or other hazards.

Home Equity Line of Credit (HELOC): Also referred to as a revolving line of credit; usually a second mortgage, which allows the borrower to obtain multiple advances up to a specific credit limit.

Index: Generally a published number or percentage, such as the yield on the One-Year Treasury Bill, which is used to compute the interest rate for an adjustable rate mortgage.

Jumbo Loan: A loan that exceeds the Fannie Mae legislated mortgage amount, which is currently $333,700. Jumbos are also called non-conforming loans.

Legal Description: Describes the location of the property which has been recorded at the county.

Lien: A legal claim or attachment against property as security for a loan.

Loan-To-Value Ratio: The ratio between the amount of any mortgages against a property divided by the sales price or appraised value.

Monthly Payment: Usually the amount of principal, interest, taxes and insurance paid each month on a mortgage loan.

Mortgage: The conveyance of an interest in real property given as security for the repayment of a loan.

Origination Fee: A fee paid to the lender for processing a loan application. The origination fee is stated in the form of points. One point equals one percent of the mortgage amount.

PITI Reserves: A cash amount a borrower must have left over after making a down payment and paying the closing costs for the purchase of a home.

Private Mortgage Insurance (PMI): Insurance written by a private company to protect the lender against loss resulting from nonpayment or default.

Purchase Contract (Earnest Money Agreement/Offer): A written agreement between a buyer and seller of real property, setting forth the price and terms of the sale, also known as a sales contract.

Qualifying Ratios: Calculations that are used in determining whether a borrower can qualify for a mortgage. The two calculations are housing expense divided by gross income, and the total debt including other monthly debt payments divided by gross income.

Rate Lock: A commitment issued by a lender to a borrower guaranteeing a specific interest rate for a specific period of time.

Title Insurance: Provides insurance that public records have been examined to insure that there are no liens or other claims against the property.

Truth in Lending Act: A federal law that requires lenders to fully disclose the terms and conditions of a mortgage including the Annual Percentage Rate (APR) and other charges.

Underwriting: The process of evaluating a loan application to determine credit worthiness and risk involved for the lender.

VA Loan: A loan that is guaranteed by the U.S. Department of Veterans Affairs, also known as a government loan.

FHA Loans

In 1934 the government set up the Federal Housing Authority (FHA) to help stimulate an economy in crisis. FHA programs were designed to help people buy their houses rather than rent. FHA programs allow more flexibility than is available for borrowers seeking conventional loans (Fannie Mae criteria). However, the FHA does not actually make the loans; they insure them.

Working with approved lenders, the FHA serves to lower the risk for the lender, thus making loans more readily available. If the borrower defaults, FHA pays the lender. Even though the insurance cost is passed down to the home owner, after paying down the loan, the borrower may drop the insurance. The equity that has been built up serves as the security the lender needs to feel comfortable with the loan. With an FHA loan, if the borrower experiences unforeseen hardships, FHA has options to help keep the home out of foreclosure. The lender must follow FHA's servicing guidelines; therefore, an FHA insured loan offers the borrower protection as well as the lender.

FHA programs do have some loan requirements, but they are not as strict as conventional loans. They generally require less down, less stringent credit, and the ability to finance a higher percentage of the value of the house. For instance, FHA only requires a minimum 3% down payment—which is low by industry standards. Also, while they do look at credit history, they are more flexible than conventional loans, looking more at the borrower's ability to repay than at any problems in the past.

Although the requirements are less strict than conventional loans, by law, the FHA can only insure loans up to a maximum amount depending on where the home is. The FHA Maximum Mortgage Limits site will let you look up the limits for the areas of choice. Likewise, the loan size is restricted to a maximum amount of the value of the home. However, it is a very high amount (often up to 97% of the value). So the regulations governing FHA loans are very liberal.

In the long run, FHA loans are much like any other except that they are generally easier to qualify for, and the borrower has more insurance against foreclosure. FHA programs also offer more than just home purchasing plans. They offer refinancing in order to lower interest rates or payment amounts; they offer remodeling money; they even offer cash out or debt consolidation loans.  Whatever your needs are, FHA may be a valid option to pursue.

Adjustable Rate Mortgage

The structure of an Adjustable Rate Mortgage (ARM) is more complex than a Fixed Rate Mortgage (FRM).  In general, the ARM has periodic times when the interest rate and payment are adjusted.  Usually, ARMs offer lower initial interest rates than a FRM, but there is a risk of higher payments in the future when the index (see below) changes.

ARMs have an adjusting time period built into the loan such as one month, one quarter, one year, three years, or five years.  A 1-year ARM would adjust every year, whereas a 3-year ARM would adjust every three years.  When the loan is adjusted at each adjusting period, the loan payment will likely change—often for the worse.  However, there are some limits built into the system to help protect the borrower (see caps below). 

Besides the adjustable characteristic of an ARM, the interest itself is more complex.  There are two levels of determining factors that affect how the ARM interest is adjusted.  First, the ARM is tied to an index which measures interest fluctuations over time.  Second, there is an interest margin that the lender adds on to the index amount.  This margin generally stays constant through the life of the loan, but the index changes according to the particular index used.  Make sure you know both which index is being used and what the interest margin is when you choose an ARM.  Find out how stable the index has been over the past years.  You may have to find an ARM with a more secure history.

The specific index will determine:

• the interest rate adjustment
• the maximum size of interest adjustment that can be made each adjusting period
• the maximum interest rate that can be given for that loan
• and any caps on payment amount

The cap placed on the size of the interest rate adjustment will determine how quickly your loan will jump to the maximum amount.  While these caps offer some security, there are some pitfalls!  Sometimes, the adjustment happens too quickly, causing the payments to rise dramatically.  Also, caps placed on the payment amount may result in a payment that won't cover the interest.  The deferred interest adds to your loan.  You pay more interest as a result.  Your loan is now into a negative amortization.  You might think you are paying down your loan, but instead, your loan is actually growing.

Payments can also jump higher when an initial discount rate expires (especially if it is at the same time that a scheduled adjustment happens).  Sellers or home builders will pay these buydown fees as an incentive or to help get terms that work for a buyer.  Once again, there are pitfalls!  Often the price of the house is raised by the amount of the fee, which in the long run, may negate the initial benefits. Also, the payment may jump so high that the home owner simply can't make the payment. 

There are other features that can be incorporated creating a variety of types of ARMs such as interest-only ARMs, payment-option ARMs, or a hybrid loan. Because of the complexity of adjustable rate mortgages, the buyer must be very careful in choosing the right ARM.  Don't be afraid to ask your lender specific questions.

RHS Loans

Rural Housing Services (RHS) loans are administered by the USDA's Rural Development staff. The Housing and Community Facilities Programs (HCFP) is part of the USDA's Rural Development. Their mission is to improve the quality of life in rural areas. Part of fulfilling that mission is providing loans and grants for housing and community facilities. Loans can be obtained for building, repairing, renovating, relocating, purchasing, and even preparing sites for construction.

They have a variety of programs. Among these are the Section 502 housing programs which are either guaranteed or direct. The Section 502 loans are designed to help rural residents that are without adequate housing and cannot obtain credit elsewhere. They must have an acceptable credit history and must be able to make the mortgage payment (estimated at 22-26% of income).

The guaranteed loans are made by the private sector but guaranteed by RHS. They help rural residents with low-to-moderate income (up to 115% of Area Median Family Income) obtain housing. Section 502 direct loans are made directly by the government. They target low and very low income families (50-80% AMI and under 50%). The terms of the loans are generally long—30-33 years, sometimes, based on need, stretched up to 38 years.

While the Rural Housing Services are committed to helping rural residents obtain affordable housing, they do have requirements that the homes be modest in size, design and costs. As with any loan, the borrower must determine which loan program will best match their needs. RHS loans are an excellent way to obtain housing that fits within your means when other loans programs will not work.

Refinancing Loans

Why refinance?

Often, home owners that already have a mortgage, choose to take out a second mortgage that pays off the first one. Typically, refinancing is done to tap in on equity or to take advantage of lower interest rates available because of improved credit, better loan options, or an improved economy.

There are several reasons why you may want to consider refinancing. These might include:

• You have built up some equity and would like to borrow against it.
• Your Adjustable Rate Mortgage has just passed the initial low-interest phase, so your payment is increasing in size.
• You have incurred an unexpected large expense that is not covered by your current cash flow.
• Your initial loan structure no longer meets your current needs.
• Due to improved credit or an improved economy, better loan options are now available.
• You want to consolidate several debts into one.
• On your original loan you did not have enough money to make a down payment, so you were required to purchase Private Mortgage Insurance (PMI), but now that you have paid the loan down, you could avoid PMI by refinancing.

Refinancing is one way of solving these problems, but you need to know some information to make sure that the benefits (possible lower interest rate and/or payment or extra cash) will outweigh the disadvantages (increased debt load or length of time before being debt free, or refinancing costs). You don't want to be surprised at the loan closing with costs you are not prepared for.

Potential problems associated with refinancing

Remember that refinancing will use current appraisal values, so the current real estate market will determine whether that is higher or lower than the amount at which the home was originally valued. Although this may go in your favor, in an economy slump, it may decrease the amount of money you can borrow and/or increase your interest rate. When the economy is down, your credit score may likewise go down because it is harder to make payments on time.

The length of time that you have owned your home will also influence your refinancing options. Your payment history, the new loan guidelines defining the length of time you must have owned before refinancing, and the amount of equity you currently have in your home will all come into play as you pursue your options.

Some of the costs that you may incur when refinancing

The costs assiciated with refinancing may vary depending on the conditions of the original loan and the specific details of the refinanced loan. However, these are some industry standards that you should keep in mind:

• the same type of loan fees as in your original loan (such as appraisal costs, attorney and inspection fees, application fees, and title search fees)
• early payment penalties (from your original loan)
• long term costs (such as higher interest rates for no cost financing)

As with any financing, you should weigh all the factors relevant to your loan.

Jumbo Loans

The Federal National Mortgage Association (FNMA [dubbed Fannie Mae]) and the Federal Home Loan Mortgage Corporation (FHLMC [dubbed Freddie Mac) are two government sponsored enterprises authorized to make loans and guarantee loans. These two entities control about 90% of the secondary mortgage market. The loans are not government guaranteed. These corporations just establish standards and guidelines for the market. Loans that fit within those guidelines are called "conforming" loans.

So what does all this have to do with jumbo loans?

Well, every year these entities publish the current loan limits. The loans that are too large to fit within the industry established guidelines are called non-conforming or jumbo loans. These non-conventional loans are harder to find funding for since they are not backed by Fannie Mae and Freddie Mac. They are a higher risk, and therefore, harder to obtain. The interest rate is generally higher, and often, the down payment requirements are higher. However, there are lenders that will fund them.

The up side is that there is more flexibility for the purchaser by way of their ability to purchase the home they actually want with involvement in negotiating the terms. Sometimes this can be worth the extra cost and effort. As with any loan, review your options before making any final decisions.

Reverse Mortgage Loans

A reverse mortgage is a loan taken by senior citizens on the equity of their home—a loan that they will not pay back as long as the home is their principal residence. Although there are no monthly payments, the interest does build up. However, the lender will not loan all the equity; only a portion of the value of the house will be used to calculate the amount available. Usually the first mortgage is paid off, or only a very small balance remains. Sometimes any remaining balance on the first mortgage is paid off from the proceeds of the reverse mortgage. The reverse mortgage money can be taken in several ways:

• Equal monthly payments
• A line of credit,
• A combination of the two.

While a reverse mortgage and a home equity loan both rely on the borrower having equity in the home, a reverse mortgage is different from a home equity loan in many ways. The major difference is that a reverse mortgage does not have payments as long as the home is the borrower's principal residence. However, there are other differences as well. The reverse mortgage is based on age, current interest rate, equity, and the value of the home, but is not based on income; whereas, a home equity loan is based on the borrower's qualifications for a loan, such as a high enough debt-to-income ratio.

The most popular reverse mortgages are the HUD federally-insured private loans. HUD reverse mortgages, offered through the Federal Housing Administration (FHA), require that the borrower:

• Be a homeowner
• Be 62 years or older
• Own the home, or have a low mortgage that is paid off with proceeds from the reverse mortgage at closing
• Must live in the home as a principle residence

Along with no payments, another advantage of a reverse mortgage is that there are no restrictions on how the loan proceeds must be spent. The terms of the loan specify the length of the loan.  For instance, as the homeowner, you may take out a 20-year reverse mortgage loan.  Even if you outlive the loan, you still don't have to pay it back as long as it is still your principal residence.  And even better, the money is tax free.

So does this all sound too good to be true?

There are some disadvantages. For instance, reverse mortgages are extremely expensive. Also, they are not really free. The equity in your home is disappearing. Not only is the loan going against your equity, so is the interest on the loan and the interest on the interest. So why is that a problem? The very real worry is that the money will run out before all the many future expenses that may come your way. So before taking out a reverse mortgage, you should weigh all the possible risks, determine a financial plan for the future years, and look at other options first.  An educated decision is always best.