Mortgages from A to Z: Terms You’ll Hear During the Homebuying Process
Whether you’re buying your first home or your third, you’re bound to hear some new words and phrases during the mortgage process. Here are some of the most commonly used terms — and their definitions — to help make the homebuying process a little less confusing.
Adjustable Rate Mortgage (ARM): The interest rate on an adjustable rate mortgage loan changes at specific times over the life of the loan based on changes in an independent index. Interest rate or payment changes may be capped; if the latter occurs, negative amortization may result.
Amortization: A loan is repaid in equal installments, calculated over the term or life of the loan. In the early years, most of the loan payment is applied to interest while in the latter years, most is applied to principal.
Annual Escrow Statement: Each year, the servicer will forward an itemized statement showing the payments collected over the prior 12 months and how they were applied to principal, interest, taxes, and insurance. The statement should also disclose when the tax and insurance payments were made.
Annual Percentage Rate (APR): The total cost of a loan calculated on an annualized basis. APRs make it easier to compare loan products with different rate and point combinations.
Appraisal: Appraisals estimate the market value of a home based on comparisons with similar properties. Unlike a home inspection, the appraisal does not produce a detailed assessment of the systems or structure of the property.
Appreciation: The value of a property may increase, or appreciate, over time. Two factors that influence the value of a home are the economic health of the region and how well the property is maintained.
Assumption: Under an assumption, an individual takes over the existing mortgage of a property with the approval of the servicer. However not all mortgage products may be assumed.
Automated Underwriting: Automated underwriting is a computer-based approach that enables a lender to process a loan application more quickly, efficiently, and objectively — and use more sophisticated measure of risk.
Biweekly: For most loans, payments are made on a monthly basis. However, with biweekly mortgages, payments are made every other week. Because each payment is equal to ½ the monthly payment, the equivalent of 13 monthly payments are made over a year. (In other words, 52 weeks divided by 2 equals 26 biweekly payments; 26 biweekly payments equal 13 monthly payments.)
Buyer Agent: A buyer agent is a real estate agent who represents you during the purchase of a home. A buyer agent walks you through the homebuying process, offers advice, schedules home tours and explains the pros and cons of neighborhoods and properties. The buyer agent also presents offers and negotiates on your behalf.
Certified Check: A certified check is guaranteed by a bank or financial institution. They have verified that sufficient funds exist in the account to cover the check and have set those funds aside. Thus, a certified check essentially functions as cash.
Closing: The final step in taking ownership of a purchased property. At the closing or settlement, you sign legal documents, make your own down payment and pay closing costs, at which point ownership of the property is legally transferred from the seller to the buyer.
Closing Costs: Fees paid at the closing of a real estate transaction by the buyer and seller, including fees from your lender or third parties for services involved in the transfer of property, such as appraisals, inspections and title searches. These costs are itemized on the HUD-1 Settlement Statement. Closing costs may range from 3 percent to 10 percent of the sales price of the home.
Closing Disclosure Statement: A few days before closing, your lender will provide you with a Closing Disclosure Statement which details exact closing costs.
Community Property: Property acquired by husband, wife or both during marriage which gives each spouse an interest in the property whether each appears in the title or not.
Condominium: A type of property ownership in which the owner holds title to an individual living unit and shares ownership of the common areas.
Contingency: A condition on the sales contract that must be met to make the contract legally binding. Typical contingencies include financing and appraisal.
Conventional Mortgage: If a mortgage loan is not insured or guaranteed by the federal government, it is considered to be a conventional loan.
Cooperative (Co-op): Co-ops or cooperatives are a type of property ownership in which each co-op owner holds a share in the corporation that owns the entire building.
Credit Report: Three independent reporting agencies (Experian, TransUnion and Equifax) provide credit reports, which include a person’s credit and payment history and current debt.
Credit Score: Based on your credit report, your credit score is a three-digit number representing creditworthiness. Your credit score identifies you as having bad, fair, good or excellent credit.
Deed-in-lieu of Foreclosure: The servicer agrees to accept the deed to your property in case of loan default. This option is typically considered only after all others have been explored.
Depreciation: The value of a property may decrease, or depreciate, over time. Two factors that influence the value of a home are the economic health of the region and how well the property is maintained.
Discount Points: One discount point is 1 percent of the loan amount. These points represent interest paid up front to the lender, rather than over the life of the loan. Typically, the higher the interest rate, the lower the discount points, and vice versa.
Discretionary Expense: Discretionary expenses are within the control of the individual (food, entertainment, etc.), unlike fixed expenses which cannot be changed (car payment, cable bill, etc.).
Down Payment: The amount of a home’s purchase price paid in cash at the time of the sale. Down payments typically range from 3 percent to 5 percent for first-time homebuyers.
Earnest Deposit (Earnest Money): A portion of the down payment that is placed in escrow with the real estate agent when the sales contract is accepted. The earnest money deposit indicates the buyer’s firm intention to purchase the property in question. If the contract is accepted by the seller, these funds will be for the purchaser’s down payment and closing costs.
EnergyStar: The U.S. Environmental Protection Agency (EPA) and the U.S. Department of Energy (DOE) award EnergyStar labels to products that exceed minimum national efficiency standards. These high-performance products reduce energy costs each month they are in use.
Equity: The percentage or amount of your home that you own, calculated by subtracting your outstanding mortgage balance (principal only) from the fair market value of your home. Equity increases over time as the mortgage is paid down or if the property increases in value.
Escrow Accounts: Lenders typically collect 1⁄12 of the annual payments due on property taxes plus hazard and mortgage insurance premiums. These monthly payments are placed in an escrow account, from which the lender draws the tax and premium payments when they fall due.
Fixed-Rate Loan: The interest rate on a fixed-rate mortgage loan will not change throughout the life of the loan.
Forbearance: Under the terms of a formal, written agreement between the borrower and the servicer, the borrower’s mortgage payments are reduced or suspended for a specific period of time. At the end of the period, the borrower is required to resume regular monthly payments plus an additional amount to make up for the past-due amount.
Foreclosure: The legal process by which a lender sells a property because the loan is in default.
Four Cs: In traditional underwriting, the lender examines the Four Cs to determine whether to grant the loan — Collateral, Capacity, Credit and Capital.
Good Faith Estimate: Within three days of taking an application, the lender or mortgage broker must provide to the borrower an estimate of the closing or settlement costs.
Government Mortgages: Mortgage loans that are insured or guaranteed by the federal government.
Gross Monthly Income: The amount an individual earns before taxes and other deductions are taken out of the paycheck.
Homeowner’s Insurance: Your homeowner’s insurance provides coverage for your property against things such as fire, theft and storm damage. The cost is usually included in your monthly mortgage payment.
HVAC: HVAC refers to the heating, ventilation, and air-conditioning system of a home.
Home Energy Audit: A home energy audit reviews where energy is used and wasted in a home.
Home Energy Rating System (HERS): A HERS audit examines the energy performance of the heating, cooling, and hot water use of a home in comparison with a “standard” home. The results of the study can be used to decide which energy-saving steps to take.
Home Inspection: A home inspection, conducted by a certified inspector, includes a detailed review of the structure and systems of the home. The inspection report itemizes the condition of each item inspected and makes recommendations on how to address any deficiencies. This inspection is not required by a lender, but is strongly recommended.
Home Warranty: Home warranties generally cover repairs to a specified part of a home, such as major appliances or the plumbing, electrical, heating, and air-conditioning systems.
Housing Expense Ratio: In traditional mortgage underwriting, the housing expense ratio is used as a guideline to calculate how large the monthly housing expense payments should be, based on gross month income. For example, if a mortgage product has a housing expense ratio of 33 percent, the borrower’s monthly housing expenses should not exceed 33 percent of his or her gross monthly income.
HUD-1 Settlement Statement: The HUD-1 Settlement Statement is required at closing. It itemizes all of the closing or settlement costs paid by both the buyer and the seller. Both parties have the right to review the HUD-1 statement 24 hours before the scheduled closing.
Interest: Interest is what your lender charges you for the use of their money in purchasing your home.
Joint Tenancy: A form of ownership under which owners have equal interest in the property and may sell their interest to whomever they choose. When one owner dies, the surviving owner(s) automatically inherit that share.
Loan Estimate (LE): Your lender will provide you with a loan estimate of what your closing costs will be to obtain a loan and purchase a specific type of property.
Loan Modification: With a loan modification, the servicer changes one or more of the terms of the loan to help the borrower bring the defaulted amount current. This option is generally used with borrowers whose financial problems are expected to be long term.
Loan Officer: Unlike a mortgage broker who has relationships with dozens of lenders, a loan officer works for only one lender. The loan officer should work with an applicant to make the best “match” between the applicant’s financial situation and the lender’s loan products.
Loan to Value (LTV): The loan to value is calculated by dividing the unpaid loan balance by the current value of the property.
Manufactured (Chassis-Built) Home: A factory-built home on a permanent frame with a removable transportation system, delivered and permanently attached to a site-built foundation.
Modular Home: A home constructed on an assembly line on conventional home floor joists and delivered to the site on a trailer.
Mortgage Broker: A mortgage broker acts as the intermediary between a borrower and the lender. Brokers must specify up front exactly how they are being paid for their services.
Mortgage Loan (Deed of Trust): People use mortgage loans to make large real estate purchases without having to pay the entire purchase price up front. The Mortgage of Deed of Trust is the recorded evidence of the promise to repay the loan; if the loan is not repaid as promised, the lender may take over the property.
Mortgage Insurance: Also known as Private Mortgage Insurance (PMI). If you pay less than 20 percent down, you’ll be asked to pay for PMI, which protects the lender in case you default on your loan. PMI is usually included in your monthly mortgage payment; the fee can be eliminated and your monthly mortgage payment reduced once you achieve 20 percent equity in your home. Mortgage insurance also reimburses the lender or investor for losses incurred during a foreclosure.
Multiple Listing Service (MLS): A listing of properties for sale maintained by local members of the National Association of REALTORS®.
Negative Amortization: Negative amortization may occur on adjustable rate mortgage loans with payment caps. If the cap is reached, the difference between what the borrower is paying and what he or she would pay without the cap is added to the loan balance — resulting in negative amortization.
If an individual has no traditional history of credit — credit cards, or student or car loans — he or she may document a good payment record using other sources, including rent, utilities, telephone, cable payments, and other accounts.
Note: The Note is signed by the borrower at closing and is the formal promise to repay the mortgage loan according to the terms specified in the Note.
Origination Point: Lenders may charge origination points to offset the administrative costs of processing and underwriting the loan. Each point is 1 percent of the loan amount.
Panelized Home: Walls, floors and roof in small panel form are assembled at the site and attached to a foundation.
PITI: A mortgage payment includes four parts — Principal, Interest, Taxes, and Insurance.
Precut Home: Lumber is cut to specific lengths at the factory and then the home is constructed by workmen at the permanent site.
Predatory Lenders: There is no single, clear-cut definition of predatory lending. Basically, a lender exhibits predatory behavior when placing its interests above the interests of the borrower. For example, a predatory lender will not hesitate to approve someone for a loan amount they cannot possibly afford.
Preforeclosure Sale: Under this arrangement, the servicer agrees to accept the proceeds from the sale of a home even though the amount is less than owed.
Prepayment Penalty: If the borrower makes an additional principal payment or pays off the loan more quickly than the prescribed payment schedule, that borrower could incur a prepayment penalty.
Prepays: The lender may collect certain expenses at closing in advance of when they are due, such as collecting one full year’s premium for mortgage insurance and/or hazard insurance to set up the escrow accounts.
Principal: The amount of money you’ve borrowed for your mortgage loan.
Private Mortgage Insurance (PMI): Also known as Mortgage Insurance. If you pay less than 20 percent down, you’ll be asked to pay for PMI, which protects the lender in case you default on your loan. PMI is usually included in your monthly mortgage payment; the fee can be eliminated and your monthly mortgage payment reduced once you achieve 20 percent equity in your home. Mortgage insurance also reimburses the lender or investor for losses incurred during a foreclosure.
Property Taxes: Property taxes are assessed against houses — usually by the county government where the house is located — to help pay for public roads, school systems and other items.
R-value: The R-value measures the resistance to heat flowing through insulation over time. Insulation with greater resistance (and a higher R-value) means that heat enters or leaves more slowly. The U.S. Department of Energy has determined the appropriate R-values for each area of the country.
Rate Lock-In: A written agreement under which the lender will lock in or guarantee an interest rate/point combination for a period of time after taking the loan application.
Refinance: Paying off one mortgage with the proceeds of another mortgage on the same property — usually to reduce the interest rate and mortgage payment.
Reverse Mortgage: For homeowners age 62 or older, it is possible to get a reverse mortgage, under which they receive funds according to a schedule they select. The amount owed is typically not repaid until after the senior leaves or sells the home or it passes into an estate. Even then, neither the senior or the senior’s estate can be required to pay more than the value of the home.
Second Mortgage: Second mortgages are so-called because the loan is subordinated to the first mortgage. In other words, the second mortgage lender stands in line behind the holder of the first mortgage in case of a foreclosure.
Servicing: The process of collecting monthly loan payments is known as servicing the loan. The original lender may service the loan or may transfer the servicing to another lender. In fact, servicing transfers may occur at any point over the life of the loan. But the basic terms of the mortgage loan remain unchanged.
Sole Ownership: Under sole ownership, title to the property is held in one person’s name only.
Survey: A drawing or map of the precise boundaries of the property as well as easements, rights of way and other physical features.
Tenancy by Entirety: Married couples may hold title as “tenants by entirety.” When one spouse dies, the property is automatically inherited by the surviving spouse.
Tenancy in Common: If title to the property is held using this option and one owner dies, that ownership may go to his or her heirs, rather than to the surviving owner(s).
Term: The term is the maximum period of time over which the mortgage is repaid.
Title: A legal document evidencing the legal ownership of a property.
Title Insurance: Title insurance protects the holder of the policy against loss resulting from disputes over ownership of the property. The borrower is required to buy a policy for the lender and should also buy a policy to protect their own interests as well.
Total Debt Ratio: In traditional mortgage underwriting, the total debt ratio is used to calculate how large the monthly payments on housing expenses and other debts (like student and car loans, credit card debt, etc.) should be, based on gross monthly income. For example, if a mortgage product has a total debt ratio of 38 percent, the borrower’s housing expenses plus other debts should not exceed 38 percent of his or her gross monthly income.
Townhouse: A type of condominium in which one owns an individual townhouse living unit and shares ownership of the common areas.
Transfer of Servicing: At any point, the lender or servicer collecting the mortgage payments may transfer that responsibility to another servicer. The basic terms of the mortgage will remain unchanged and borrowers have a 60-day grace period in case their payments go to the wrong place.
Truth in Lending: Within three days of taking an application, the lender or mortgage broker must provide a borrower with a Truth in Lending Disclosure statement, showing the total amount to be financed, all of the costs to be paid on an annualized basis (the APR), the payment schedule and total of payments you will make, the prepayment and late payment policy.