Mortgage Glossary
Annual Percentage Rate (APR) is the rate, as a percentage of the loan amount, that a bank, credit card company, or other lender charges you for borrowing each year. Because the APR includes any fees the lender charges, it may be higher than the loan’s interest rate. Loan issuers are required by the federal Truth in Lending Act to tell consumers what APR they will be paying.
The lower the APR, the less it may cost you to borrow the same amount of money for the same term. For example, your finance charge on a $1,000 credit card balance would be $9.00 the first month if the card’s APR is 9%, but $18.00 if the APR is 18%. In contrast, the annual percentage yield (APY) is what you earn on an interest-bearing account. If the interest compounds, your APY will be higher than the interest rate the account pays.
You can use APR as one of many tools for comparing loans, including mortgage loans, from various lenders. But keep in mind that other borrowing costs, such as mortgage closing costs, are not included in the APR, so you’ll want to look at the total cost of borrowing before choosing a lender.
Adjustable Rate Mortgage (ARM) loans offer an interest rate that is fixed for an initial period, and then adjusts at regular intervals. They have a lower starting rate than a fixed-rate loan, so monthly payments are smaller. Rate increases are capped to limit your risk.
Balloon Mortgage offers lower monthly payments than a fixed-rate mortgage on the same principal, but for a substantially shorter term — typically 5, 7, or 10 years. Unlike a fixed-rate mortgage, where the monthly payments remain the same for the term of the loan, the final payment on a balloon mortgage is a lump sum, or balloon payment, significantly larger than the usual monthly payments. In some cases, the low monthly payments cover only the interest, and you must pay the entire principal in the last payment. Some balloon mortgages offer a conversion option that lets you extend the loan at a new interest rate.
A balloon mortgage can be a smart choice if you anticipate being able to refinance at an attractive rate at the end of the term, or if you are confident you will have enough money to pay off the loan. But if you lose your job or your house depreciates in value, you may be unable to refinance if you have to and risk losing your home.
Closing Costs are the expenses (not including the price of the property) you pay to finalize a real estate transaction. There are two types of closing costs — prepaid and non-recurring. Prepaid costs are those expenses that you will have to pay again periodically, such as real estate taxes and home insurance premiums. Non-recurring costs pay for the property transfer from the seller to the buyer, and may include a filing fee to record the transfer of ownership, the mortgage tax, title search and title insurance expenses, appraisal fee, and any costs paid to the lender to reduce rates.
Before you close, you will be given a good faith estimate (GFE) of what the closing costs will be, so you know approximately how much you need to have in your bank account to write the checks at closing. Some but not all closing costs are tax deductible, so be sure to consult with your tax adviser.
Credit, in its simplest meaning, is your ability to borrow money. Being creditworthy, or having good credit, can help you get the best interest rates on a mortgage, loan, or credit card as well as qualify for a job or apartment. You can build and maintain good credit by using it wisely — borrowing only as much as you can pay back comfortably and making timely payments — while taking care to safeguard against ID Theft.
Credit Bureaus, also known as credit reporting agencies, collect information about your financial history and summarize it in your credit report. Three major agencies, Experian, Equifax, and TransUnion, track information about how you use credit — how much you owe and the timeliness of your payments. They also store other records about you, such as your present and past addresses, Social Security number, employment history, records of lenders and other businesses that have accessed your credit report, and information in the public record, including bankruptcies, liens, and wage garnishments. However, there is some information that credit bureaus, by law, don’t collect, such as your age, race, religion, political affiliation, or health records.
Credit reporting agencies provide your credit report to anyone with a legitimate business need to know your credit history, including banks, mortgage lenders, credit card companies, landlords, and current or prospective employers.
Credit Check is an inquiry by any legitimate business that needs to know your credit history. Banks, mortgage lenders, credit card companies, landlords, and current or prospective employers can request a credit report from a credit bureau to assess your creditworthiness. When you apply for a loan, you typically pay the cost of the credit check as part of the application fee.
It’s smart to perform periodic credit checks on yourself as well. Experts recommend that you check your credit reports for errors at least once a year. Under the Fair and Accurate Credit Transactions Act (FACT Act), which was enacted to help consumers safeguard against identity theft, you can request a free annual credit report from each of the three major credit bureaus at www.annualcreditreport.com.
Credit Report is a summary of your credit history and is used by banks, mortgage lenders, credit card companies, landlords, employers, and other businesses to assess your creditworthiness. The three major credit bureaus, Equifax, Experian, and TransUnion, collect information about how you use credit — how much you owe and your pattern of payments — as well as other records, including your Social Security number, employment history, credit history, records of businesses that have accessed your credit report, and information in the public record, including bankruptcies, liens, and wage garnishments. However, by law, your credit report says nothing about your age, race, religion, political affiliation, or medical records, among other things.
Credit Score is a number assigned to you by a credit bureau that reflects its assessment of your creditworthiness. Many lenders use your credit score rather than your credit report when deciding whether to approve you for a loan, since it sums up a lot of detailed information about your financial habits in a single number.
Credit scores range from 300 to 850, with the top 20% of credit profiles receiving a score over 740 and the lowest receiving scores under 620. A higher score typically means you qualify for lower interest rates, while a negative credit event, such as a bankruptcy or unpaid taxes, can significantly reduce your score.
Because your score is based on the information in your credit report, it’s very unlikely that you’ll have a low score if your credit report is in good shape. Nonetheless, most experts recommend reviewing your score occasionally to see how credit bureaus assess your credit risk. Unlike your credit reports, which can be obtained for free once a year, you’ll have to pay a modest fee to see your score.
Down payment is the amount of cash you put down when you buy real estate. It is the difference between the total cost of the property and the amount you borrow with a mortgage loan. Down payments are usually 5% to 20% of the total cost of a home. For example, if your house costs $250,000, then you will usually need between $12,500 and $50,000 for the down payment.
Equal Credit Opportunity Act (ECOA) is a federal law that makes it illegal for banks, credit card companies, and other lenders, to discriminate in granting credit based on race, color, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to contract), whether all or part of the applicant’s income derives from a public assistance program, or whether the applicant has in good faith exercised any right under the Consumer Credit Protection Act. Lenders are supposed to look only at your actual, objective financial history and credit score to determine your creditworthiness.
Equity is the difference, often figured as a percentage, between the current value of your house, or what you could sell it for today, and the amount you still owe on your mortgage. For example, if your house is now worth $300,000 and you still have $200,000 to pay on your mortgage; your equity is $100,000, or 33%.
Your equity in your home can increase in two ways, First, it increases as you pay off the principal of your mortgage. So when your mortgage is fully paid, your equity is 100%. But your equity also increases if your home’s value rises. So let’s say you buy a house for $250,000 with a $50,000 down payment and a $200,000 mortgage. Then your equity is 20%. But if the house is reappraised at $300,000, your equity rises to $100,000, or 33%. However, if your house is reappraised at a lower price, your equity decreases even if you have paid off part of your mortgage.
Federal Deposit Insurance Corporation (FDIC) was established in 1933, after the bank failures of the Great Depression, to protect bank deposits. The FDIC insures up to $100,000 per depositor per bank. The FDIC also insures up to $250,000 per depositor per bank for tax-deferred or tax-free retirement accounts, provided the assets in those accounts are invested in bank products. If the bank goes under, the FDIC will refund the money in your account up to the limit.
Individual and joint accounts are insured separately, so if you have both types of accounts at a single bank, your total deposits may be insured up to $200,000. You can learn more about the FDIC at their website, www.fdic.gov.
Fixed-Rate Mortgage has a fixed interest rate over the term of your loan, regardless of whether bank interest rates rise or fall. This means that your borrowing costs and monthly payments will stay the same, so you know exactly how much your mortgage will cost you right from the beginning.
When interest rates are going up, fixed-rate mortgages protect you from rising monthly mortgage costs. But if interest rates drop, you would have to refinance to get the lower rate and reduce your monthly payments. A fixed-rate mortgage may be more difficult to qualify for than an adjustable-rate mortgage, since your initial mortgage payments would likely be higher.
If you expect to stay in your home for many years, or you’re just more comfortable knowing what you’ll be paying from month to month, a fixed-rate mortgage may be right for you.
Good Faith Estimate (GFE) is a written estimate your mortgage lender must provide that lists the closing costs you can expect to pay — usually 5% to 10% of the amount you are borrowing — when you finalize the purchase of your home at closing.
The lender must send you the GFE within three days of receiving your loan application. This will help you anticipate what your total purchase costs will be.
Home Equity Loan (HELOC) is a way of using the equity you have built in your home to get cash. You can usually borrow up to 80% of the equity in your home, so if your house is worth $200,000 and you have a $100,000 mortgage, you may be able to borrow up to $80,000 against your home. You generally must make monthly payments to repay the loan over its term.
Low interest rates and the ability, in many cases, to deduct the loan interest on your tax return make home equity loans an attractive option for financing major expenses, such as home renovations or tuition costs. But because your home serves as collateral for the loan, you want to make sure you can comfortably manage your monthly payments, or you could risk losing your home.
You might also consider a home equity line of credit, sometimes referred to as a HELOC, which is a revolving credit arrangement similar to a credit card. Your credit line, or limit, is fixed, but you can draw against it at your convenience rather than receive the entire loan amount as a lump sum. Whatever amount you pay off you can use again. Because you pay interest only on the amount you borrow, you may save money with a line of credit. Unlike home equity loans, which often have fixed interest rates, home equity lines of credit have variable interest rates. With some lenders, you may be able convert your HELOC to a loan and lock the rate at any time to suit your needs.
Interest can mean a lot of different things when it comes to your money. Interest is what it costs to borrow money — whether you are paying off a loan or mortgage, a line of credit, or a credit card balance. Interest is usually figured as a percentage of the amount you borrow over a specified period of time, usually a year. For example, interest on your mortgage might be 5.75% annually. Interest also refers to the income you earn on certain investments and bank products, like bonds, savings and money market accounts, and certificates of deposit (CDs). The share you own, or the right you have, in a real estate property or other asset is also your interest. For instance, the equity you own in your home is your interest in the property.
Interest-Only Mortgage lets you make low monthly payments for a fixed term — typically five or seven years — that cover only the interest on your mortgage. At the end of the interest-only term, the balance is due as a lump sum or as a series of substantially higher payments. Unlike a fixed-rate mortgage, where the monthly payments remain the same for the term of the loan, your initial payments on an interest-only mortgage will be lower than on most other mortgage loans, while the final payment or payments will be substantially higher as you pay off the principal.
Interest Rate is the percentage you earn annually on a savings account, CD, or bond. In the case of bonds, the interest rate is figured as a percentage of the face value.
If the interest on your deposit account compounds, your annual percentage yield (APY) is higher than the interest rate you earn. But if the account pays simple interest, the APY will be the same as the interest rate.
Similarly, when you borrow money, the interest rate is the percentage you pay over a fixed period of time, typically a year. For instance, the interest rate on a mortgage is figured as an annual rate, such as 6.75% per year. If there are no fees or other charges associated with borrowing money, the interest rate is the same as the annual percentage rate (APR).
Line of Credit is the maximum amount you can borrow under a revolving credit arrangement with a bank, mortgage lender, or credit card issuer. When you activate the line, or borrow against it, you pay interest on the amount of money you actually borrow, not on the full amount.
So, for example, if you have a home equity line of credit for $50,000, you may borrow up to $50,000 at any time, in as many different increments as you like, and you pay interest only on the amount you have actually borrowed. If you have used $15,000, you only pay interest on that amount, and there is still $35,000 at your disposal to borrow if you need more money. Once you repay the amount you borrow, you can use it again.
A line of credit may be secured with collateral, or it can be unsecured. For example, if you have a home equity line of credit, your home serves as collateral against the amount you borrow. A line of credit on a credit card, in contrast, is unsecured.
Liquidity is the ability to convert your assets to cash quickly, with little or no loss of value. For example, the money in your savings account, CDs, and money market accounts are liquid assets, since you can withdraw the same amount as you put in, plus any interest you’ve earned in the account. Investments such as stocks and bonds are less liquid, since you may have to sell them for less than you paid if their price has dropped and you don’t have time to wait for the price to rebound. And assets such as your home, fine art, jewelry, and other collectibles are even less liquid, since it usually takes time to complete a sale, and you may have to settle for a lower price if you have to sell quickly.
A certain amount of liquidity is important, so you can meet unexpected financial demands, such as emergency repairs or medical bills. But you need to balance the benefits of liquidity with the earning potential that can only be achieved by investing in less liquid assets like real estate and securities.
Mortgage is the legal agreement you make with a lender when you borrow money to buy a home or other real estate. In exchange for advancing you money, the lender has a claim on the property as security against the amount you owe. That’s why mortgages are considered secured loans.
As you repay the loan, you build up equity in the property you purchased until you have paid it off entirely and have 100% equity. If, on the other hand, you default on your loan, the lender can repossess your home and sell it to recover the amount you owe.
Origination Fee is an amount a lender may charge for processing your mortgage application. When the fee is due, it is typically about 1% of the amount you borrow and is one of your closing costs. For example, if you are borrowing $200,000, you may pay a $2,000 origination fee, sometimes also called origination points.
PITI is an acronym for the four major components of a mortgage payment — principal, interest, taxes, and insurance. Principal is the amount you borrow. Interest is the charge, figured as an annual percentage of your loan amount that you pay for borrowing. Taxes are the local property taxes you are responsible for, and insurance is the homeowner’s insurance you are required to have. If your lender requires private mortgage insurance (PMI), this will also be figured into PITI.
When lenders calculate how much you can afford to borrow, they use PITI to determine your monthly mortgage obligation. Most lenders require that you spend no more than 28% of your pre-tax income on PITI.
Pre-Approval means a lender guarantees in advance that you can borrow up to a specific amount to buy a home, provided your financial situation does not change before you’re ready to buy. Some lenders charge a fee for preapproval, but others don’t.
Preapproval may increase your chances of getting the home you want, since you know in advance how much you can afford, and sellers may be more likely to accept your bid because you can guarantee you won’t be turned down for a mortgage.
Prepayment Penalty is a fee you may owe, depending on the terms of your mortgage, if you refinance or pay off your mortgage early. A typical prepayment penalty is 6 months’ interest, which could be a substantial sum. Prepayment penalties are illegal in many, but not all, states.
The rate you’re offered for a loan with a pre-payment penalty may be lower than if there is no penalty. This can be attractive if you’re quite certain you won’t refinance or prepay. But if, like most people, you move or refinance before the end of the loan term the prepayment fee could offset what you save in interest.
Prequalify for a mortgage means that a lender confirms the approximate loan amount you’ll be able to qualify for, given your income and debt. Unlike preapproval, prequalification is not a guarantee, since you don’t go through an application process or provide financial details. Many lenders offer free mortgage calculators on their websites to prequalify you — or help you determine approximately how much you’ll be able to borrow. That helps you know what’s in your range and what’s not, but you’ll still have to complete a mortgage application before you’re approved for a loan.
Principal is the amount you owe on a loan, not including interest charges or other fees. Conversely, principal is the amount you invest or put in the bank, not including interest or capital gains the account earns.
Private Mortgage Insurance (PMI) is required on some loan programs if your mortgage loan is more than 80% of the purchase price of your home. It’s designed to insure against the risk that you’ll default.
Lenders are legally required to tell you when you will pay off enough of your mortgage to have 20% equity in your home. When you reach that point, you usually have the right to cancel the PMI, although there may be an exception if you are considered a high-risk borrower.
Refinance is arranging to pay off an existing loan with a new loan at a lower interest rate or for a different term. For instance, you may decide to refinance your mortgage if interest rates have dropped or you want to build equity in your home faster by reducing the term of your loan. You might also refinance if your home has increased in value and you want to take out some of your equity. Or, if you’re struggling to keep up with your payments, you may refinance to reduce the amount you owe monthly.
Keep in mind you’ll pay fees and closing costs to refinance, just as you did with your original mortgage — although you may pay less if you go back to the same lender within a relatively short period.
Revolving Credit is a credit line that you can use as you need cash, up to a preset limit. Once you’ve repaid what you borrow, you can borrow it again. You pay interest only on the amount you owe at any given time, although some lenders may charge up-front or annual fees for access to the credit.
Revolving credit may be secured with collateral or unsecured. For example, a home equity line of credit is revolving credit that’s secured by your home, while most credit cards, which are another form of revolving credit, are unsecured. Used responsibly, revolving credit gives you the flexibility of available cash, with the benefit of paying interest only on what you use.
Settlement Statement is the legal document, also called a HUD1, that you receive at a real estate closing. It itemizes the closing costs you will have to pay to complete the transaction. The total costs should be similar to the amounts listed in the good faith estimate (GFE) you were given before the closing.
Tax Deductible means that you can subtract some, or all, of the dollar amount you pay for certain expenses from your annual gross income to reduce the total income on which you owe taxes. For instance, the mortgage interest you pay is usually deductible, as are the contributions you make to a traditional IRA if you satisfy the requirements for taking the deduction. You may also be able to deduct other expenses as well, such as qualified charitable donations, student loan interest, and certain out-of-pocket medical expenses.
Taking advantage of tax deductions can help you lower your tax bill, but you’ll want to discuss the deductions you qualify for and how to make the most of them with your tax adviser.
Title Insurance protects your lender’s interest in your home and real property in case its ownership is contested in court. Before you close on any property purchase, your lender will require a title search — an examination of all the property records by an attorney or title company, to ensure that the seller owns the property and has the right to sell it. But just in case something is not revealed in the title search, your lender will usually require you to obtain title insurance as added protection until you have paid off your mortgage. You may also choose to purchase additional insurance to protect your own title and claim to the property.
Title Search is an examination of property records by a title company or attorney to ensure that the person from whom you are buying a piece of property is its legal owner, and that there are no outstanding legal claims against the property. Your lender will require you to pay for a title search before the closing, or settlement, on your new home.