Glossary

This glossary is provided to help you earn about the different terms the lenders use. These terms are described in terms of mortgage loans or refinancing in general.

A

Adjustable-rate mortgage (ARM): A mortgage that does not have a fixed interest rate. The rate changes during the life of the loan based on movements in an index rate, such as the rate for Treasury securities or the Cost of Funds Index. ARMs usually offer a lower initial interest rate than fixed-rate loans. The interest rate fluctuates over the life of the loan based on market conditions, but the loan agreement generally sets maximum and minimum rates. When interest rates increase, generally your loan payments increase; and when interest rates decrease, your monthly payments may decrease.
Amortizing loan: Monthly payments are large enough to pay interest and reduce the principal on your mortgage.
Annual membership or maintenance fee: An annual charge for having the line of credit available. Charged regardless of whether or not the line is used.
Annual percentage rate (APR): A measure of the cost of credit, expressed as a yearly rate. It includes interest as well as points, broker fees, and certain other credit charges that the borrower is required to pay. Because all lenders follow the same rules when calculating the APR, it provides consumers with a good basis for comparing the cost of loans, including mortgages, over the term of the loan.
Application fee: Fees paid when an application is submitted. May include charges for property appraisal and a credit report.

B

Balloon payment: A lump-sum payment that may be required when the mortgage ends.
Buydown: When the seller pays an amount to the lender so that the lender can give you a lower rate and lower payments, usually for an initial period in an ARM. The seller may increase the sales price to cover the cost of the buydown. Buydowns can occur in all types of mortgages, not just ARMs.

C

Closing or settlement costs: May include application fees; title examination, abstract of title, title insurance, and property survey fees; fees for preparing deeds, mortgages, and settlement documents; attorneys’ fees; recording fees; and notary, appraisal, and credit report fees. Under the Real Estate Settlement Procedures Act, the borrower receives a good faith estimate of closing costs within three days of application. The good faith estimate lists each expected cost either as an amount or a range.
Conventional loans: Mortgage loans other than those insured or guaranteed by a government agency such as the FHA (Federal Housing Administration), the VA (Veterans Administration), or the Rural Development Services (formally known as Farmers Home Administration, or FmHA).
Conversion clause: A provision in some ARMs that allows you to change the ARM to a fixed-rate loan at some point during the term. Conversion is usually allowed at the end of the first adjustment period. At the time of the conversion, the new fixed rate is generally set at one of the rates then prevailing for fixed-rate mortgages. The conversion feature may be available at extra cost.
Credit limit: The maximum amount that may be borrowed under the home equity plan.

D

Discount: In an ARM with an initial rate discount, the lender gives up a number of percentage points in interest to give you a lower rate and lower payments for part of the mortgage term (usually for one year or less). After the discount period, the ARM rate will probably go up depending on the index rate.

E

Equity: The difference between the fair market value of the home and the outstanding mortgage balance.
Escrow: Holding of money or documents by a neutral or third party before closing. It can also be an account held by the lender (or servicer) into which a homeowner pays money for taxes and insurance.
Expected interest rate change: The change--increase or decrease--you expect at the first adjustment period. This amount is likely to be between -3 and +3. If you think interest rates will not change, enter 0 in this box. Some mortgages limit this amount to 2 percentage points for each adjustment period and to 6 to 8 percentage points over the life of the loan. For example, if your initial rate is 6.5%, your mortgage may go up to as much as 8.5% or down to 4.5% at the first adjustment period.

F

Fixed-rate loans: These loans generally have repayment terms of 15, 20, or 30 years; some lenders offer 40-year loans. Both the interest rate and the monthly payments (for principal and interest) stay the same during the life of the loan.
Fully-indexed rate: The interest rate that will apply after the introductory period is over in a payment-option ARM; this is not the Annual Percentage Rate (APR). This rate will be higher than the introductory rate.

G

Good faith estimate: The Real Estate Settlement Procedures Act (RESPA) requires your mortgage lender to give you a good faith estimate of all your closing costs within 3 business days of submitting your application for a loan, whether you are purchasing or refinancing a home. The actual expenses at closing may be somewhat different from the good faith estimate.

H

Home value: Purchase price if you are buying the home or appraised value if you are refinancing your mortgage.
Hybrid ARM: These ARMs are a mix--or a hybrid--of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first several years of the loan; after that, the rate will adjust annually. Hybrid ARMs are usually advertised as 3/1 or 5/1--the first number tells you how long the fixed interest rate period will be and the second number tells you how often the rate will adjust after the initial period. For example, a 3/1 loan has a fixed rate for the first 3 years and then the rate adjusts once a year beginning in year 4.
Hybrid ARMs: Hybrid ARMs are a mix, or a hybrid, of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first several years of the loan; after that, the rate could adjust annually. For example, a 3/1 hybrid ARM has a fixed interest-rate period for the first 3 years; then the rate adjusts every year after the initial 3-year period.

I

Index

The published rate that serves as a base for the interest rate charged by the lender. The lender uses the index to make changes in the interest rate on an ARM over time. No one can be sure when an index rate will go up or down.

Interest rate

The price paid for borrowing money, usually given in percentages and as an annual rate.

Interest rate caps

A limit on the amount your interest rate can increase; there are two types of interest caps:

periodic adjustment caps, which limit the interest-rate increase from one adjustment period to the next, and
lifetime caps, which limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have a lifetime cap.

Interest rate for interest-only fixed-rate mortgage

The contract interest rate for the mortgage; this is not the annual percentage rate (APR).

Interest-only ARMs

Interest-only ARMs allow you to pay only the interest for a specified number of years, typically between 3 and 10 years. This allows you to have smaller monthly payments for a period of time. After that, your monthly payment will increase--even if interest rates stay the same--because you must start paying back the principal as well as the interest each month. For some I-O loans, the interest rate adjusts during the I-O period as well.

For example, if you have a 30-year mortgage loan with a 5-year I-O payment period, you can pay only interest for 5 years and then you must pay both the principal and interest over the next 25 years. Because you begin to pay back the principal, your payments increase after year 5, even if the rate stays the same. Keep in mind that the longer the I-O period, the higher your monthly payments will be after the I-O period ends.

Interest-only fixed-rate mortgage

This is a traditional fixed-rate mortgage, but you only pay interest for the first few years. Even though your rate does not go up, your payments will go up after the interest-only period because you must start paying back the principle as well as the interest. Enter the contract interest rate for the mortgage, not the APR. For example, if the contract interest rate is 7% plus 1 point, you should enter 7.

Introductory rate

The initial interest rate of the mortgage; this is not the annual percentage rate (APR). This is usually a fairly low number, generally between 1% and 3%. This rate applies only during the introductory rate period, which may only be a few months.

L

Lender: A lender is a person or an agency like a bank that lends money.
Loan origination fees: Fees charged by the lender for processing the loan and are often expressed as a percentage of the loan amount.
Lock-in: Refers to a written agreement guaranteeing a home buyer a specific interest rate on a home loan provided that the loan is closed within a certain period of time, such as 60 or 90 days. Often the agreement also specifies the number of points to be paid at closing.

M

Margin: The number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment.
Minimum payment: The minimum amount that you must pay (usually monthly) on your account. Under some plans, the minimum payment may cover interest only; under others, it may include both principal and interest.
Mortgage: A mortgage loan or mortgage as it is normally called, is a loan taken to buy a property under a contract. The lender is given the lien on the title of the property – that can be house or a car or an industry or any other property – until the mortgage is paid off in full. Once the mortgage is paid back in full, the lender releases the lien on the property. A mortgage loan is paid off according to a contract in a given time period. The interest for a mortgage loan may be based on a fixed rate that remains the same throughout the life of the loan, or a variable or adjustable rate that varies with time or the unpaid principal as stipulated in the contract.

N

Negative amortization: Occurs when the monthly payments do not cover all the interest cost; instead of paying down the loan balance, you are adding to the amount you owe. The interest that is not paid in the monthly payment is added to the loan balance. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Negative amortization can also occur when an ARM has a payment cap that results in monthly payments that are not high enough to cover the interest due.

O

Overage: The difference between the lowest available price and any higher price that the home buyer agrees to pay for the loan. Loan officers and brokers are often allowed to keep some or all of this difference as extra compensation.

P

Payment cap

A limit on how much the monthly payment may change, either each time the payment changes or during the life of the mortgage. Payment caps do not limit the amount of interest the lender is earning, so they may lead to negative amortization.

Payment penalty

Extra fees that may be due if you pay off the loan early by refinancing your loan, usually limited to the first 3 to 5 years of the loan’s term. These fees may make it too expensive to get out of the loan. If your loan includes a prepayment penalty, be aware of the penalty you would have to pay. Compare the length of the prepayment penalty period with the first adjustment period of the ARM. Ask the lender if you can get a loan without a prepayment penalty and what that loan would cost.

Payment-option ARMs

Payment-option ARMs allow you to choose among several payment options each month. The options typically include the following:

a traditional payment of principal and interest, which reduces the amount you owe on your mortgage. These payments are based on a set loan term, such as a 15-, 30-, or 40-year payment schedule.
an interest-only payment, which pays the interest but does not reduce the amount you owe on your mortgage as you make your payments.
a minimum (or limited) payment that may be less than the amount of interest due that month and may not reduce the amount you owe on your mortgage. If you choose this option, the amount of any interest you do not pay will be added to the principal of the loan, increasing the amount you owe and your future monthly payments, and increasing the amount of interest you will pay over the life of the loan. In addition, if you pay only the minimum payment in the last few years of the loan, you may owe a larger payment at the end of the loan term, called a balloon payment.

The interest rate on a payment-option ARM is typically very low for the first few months (for example, 2% for the first 1 to 3 months). After that, the interest rate usually rises to a rate closer to that of other mortgage loans. Your payments during the first year are based on the initial low rate, meaning that if you only make the minimum payment each month, it will not reduce the amount you owe and it may not cover the interest due. The unpaid interest is added to the amount you owe on the mortgage, and your loan balance increases. This is called negative amortization. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Also, as interest rates go up, your payments are likely to go up.

Many payment-option ARMs limit, or cap, the amount the monthly minimum payment may increase from year to year. For example, if your loan has a payment cap of 7.5%, your monthly payment won't increase more than 7.5% from one year to the next (for example, from $1,000 to $1,075). Any interest you don't pay because of the payment cap will be added to the balance of your loan.

Payment-option ARMs have a built-in recalculation period, usually every 5 years. At this point, your payment will be recalculated (lenders use the term recast) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. If your loan balance has increased because you have made only minimum payments, or if interest rates have risen faster than your payments, your payments will increase each time your loan is recast. At each recast, your new minimum payment will be a fully amortizing payment and any payment cap will not apply. This means that your monthly payment can increase a lot at each recast.

Points

One point is equal to 1 percent of the amount borrowed. For example, if the mortgage is $200,000, one point equals $2,000. Lenders frequently charge points in both fixed-rate and adjustable-rate mortgages to increase the profit on the mortgage or the compensation to the lender or broker, and to cover loan closing costs. These points usually are collected at closing and may be paid by the borrower or the home seller, or may be split between them.

Primary mortgage amount

Amount of money you want to borrow; if you plan to have 2 mortgages, this is the amount of the major (or primary) mortgage.

Principal

The amount of money borrowed or amount still owed on a loan.

Private mortgage insurance (PMI)

Protects the lender against a loss if the borrower defaults on the loan. It is usually required for loans in which the down payment is less than 20 percent of the sales price or, in a refinancing, when the amount financed is greater than 80 percent of the appraised value. Once you have 20 percent equity in your home, PMI is cancelled. Depending on the size of your mortgage and down payment, these premiums can add $100-$200 per month or more to your payments.

Purchase price or home value

The amount listed in your purchase contract, the estimated price of a home you are considering, or the appraised value of the home you are financing.

S

Second mortgage: A second mortgage is a loan taken after the first (or primary) mortgage, and it is secured by the same property as the first. A property can have multiple loans against it. The loan which is registered with the county or city registry first is called the first, or primary, mortgage. The loan registered second is called the second mortgage. Second mortgages are called subordinate mortgages because, if the loan goes into default, the first mortgage gets paid off first before the second mortgage gets any money. Thus, second mortgages are riskier for the lender, and generally carry a higher interest rate.

You can use a second mortgage to make up the difference between the down payment you can afford and 20 percent of the home’s value. For example, your down payment may be only 10 percent; your primary mortgage would be 80 percent and your second mortgage would be the remaining 10 percent. This allows you to avoid paying PMI premiums.
Second mortgage amount: Amount of money you plan to borrow as a second mortgage. A second mortgage is a loan taken after the first (or primary) mortgage, and it is secured by the same property as the first. The loan which is registered with the county or city registry first is called the first, or primary, mortgage. The loan registered second is called the second mortgage. Second mortgages are called subordinate mortgages because, if the loan goes into default, the first mortgage gets paid off first before the second mortgage gets any money. Thus, second mortgages are riskier for the lender, and generally carry a higher interest rate.

You can use a second mortgage to make up the difference between the down payment you can afford and 20 percent of the home’s value. For example, your down payment may be only 10 percent; your primary mortgage would be 80 percent and your second mortgage would be the remaining 10 percent. This allows you to avoid paying PMI premiums. A second mortgage is often a home equity loan or line of credit.
Second mortgage term: Number of years you expect to have a second mortgage. Most second mortgages are for 10 years or fewer.
Security interest: An interest that a lender takes in the borrower’s property to ensure payment of a debt.
Settlement or closing costs: May include application fees; title examination, abstract of title, title insurance, and property survey fees; fees for preparing deeds, mortgages, and settlement documents; attorneys’ fees; recording fees; and notary, appraisal, and credit report fees. Under the Real Estate Settlement Procedures Act, the borrower receives a good faith estimate of closing costs within three days of application. The good faith estimate lists each expected cost either as an amount or a range.

T

Thrift institution: Is a general term for savings banks and savings and loan associations.
Type of ARM: The initial rate period and the adjustment period for the loans you are considering. The most common ARMs are 2/1 (sometimes called 2/28), 3/1 (sometimes called a 3/27), 5/1, 7/1, and 10/1. You will need to compare at least one ARM and one fixed-rate mortgage.

V

Variable rate: An interest rate that changes periodically in relation to an index. Payments may increase or decrease accordingly.