Mortgage Terminology
Understanding the Mortgage Banking Lingo
Principal: The amount of the mortgage loan being borrowed.
Interest Rate: The specified rate of interest on which both per diem interest payments payable at closing as well as monthly mortgage payments will be based. This figure is fixed and only able to be changed through an adjustment mechanism built into the Mortgage Note (as in the case of an Adjustable Rate Mortgage), or by some form of modification agreement mutually agreeable and executed by both lender and borrower.
Term: The period of time over which you are committing to repay the principal mortgage amount. Typically broken down at 15, 20 and 30 year increments, the shorter the term, the lower the interest rate. Term is a variable that can be adjusted to get the mortgage payment where you want it to be. While usually longer term loans have higher interest rates, they result in lower monthly payments, which are an attractive feature to many people. Provided there is no prepayment penalty incorporated into the Mortgage Note, a borrower can always add more principal to the mortgage payment to expedite the payoff process, or, if funds are tight, what is required to be paid each month is much lower than what a shorter term loan would have.
Point: Also referred to as a discount point, it represents 1% of the principal mortgage amount. Single, multiple or fractional points amount to an upfront charge in exchange for a lower interest rate. The more points a borrower pays, the lower the interest rate incorporated into the Mortgage Note. Borrower’s having little cash available for closing might find it advantageous to choose a lower or zero point interest rate, which is higher and results in a larger mortgage payment over the life of the loan, but provides some relief in the way of upfront expenses at the settlement table. This charge is typically paid at closing as part of the borrower’s expense on the settlement sheet.
Application Fee: This fee is usually collected at the time of the mortgage interview, and in most cases it covers the lender’s cost of pulling credit and having the property appraised. Sometimes a lender will charge a separate appraisal fee, in which case a lower application fee should be charged.
Appraisal: A market analysis of the current value of the subject property performed by a certified real estate appraiser. Typically, the value for loan approval purposes is the lesser of the appraised value or the purchase price stipulated in the sales agreement; in the event a refinance, the appraised value is the only figure used.
PITI: Principal, Interest, Tax & Insurance. These comprise the total monthly mortgage payment, both the amortizing principal component as well as collection of 1/12 of the annual property taxes and homeowners insurance premiums.
Buy Down Fee: A fee paid upfront in exchange for a temporary reduction in interest rate and monthly mortgage payment for a specified period of time. After the buydown period is expired, the interest rate returns to the contractual rate in the Mortgage Note and the monthly mortgage payments are adjusted accordingly.
Temporary Subsidy Buydown: A temporary reduction in the interest rate and monthly mortgage payment in exchange for a fee (Buy Down Fee). The proceeds of the fees are intended to subsidize the total mortgage payment by having a portion added monthly to the reduced payment paid by the borrower thus providing the lender with a full mortgage payment as provided for by the terms of the Mortgage Note.
Commitment Fee: A fee paid by the borrower to the lender upon the lender’s approval of the mortgage loan request. It is usually non-refundable and intended to provide a motivation for the borrower to follow through with the remainder of the mortgage process, particularly because the lender has most likely already committed to deliver a closed mortgage loan to an end investor and does not want the customer to walk away from the arrangement. In the incredibly competitive mortgage business these days and to remain competitive, not too many lenders charge commitment fees anymore.
Escrow: An account into which 1/12 of the annual property taxes, homeowners insurance, and PMI, if applicable, are deposited. The lender then pays these items to the appropriate party when they come due. Lenders usually require escrow. It is beneficial to the borrower in that they are able to pay their taxes and insurance premiums incrementally throughout the year instead of in lump sums that can be much more painful financially. To the lender, it provides security in knowing that the properties on which they have first lien position are both insured and not going to go up for tax sale.
Downpayment: The portion of the purchase price of the subject property that the borrower is putting up from his/her own funds. This is the borrower’s investment in the property and viewed to some degree as a gauge of risk to the lender. Borrower’s that put more money into a deal are much less likely to walk away from the property if things get tough financially. With that security and the resulting reduced required investment on their part, a lender can usually be more lenient in certain underwriting issues when the borrower’s downpayment is larger.
PMI: An abbreviation for Private Mortgage Insurance. This is an insurance policy taken out on very low downpayment loans. The premiums are paid by the borrower but only the lender stands to benefit from the policy. It is typically imposed on loans where the borrower is putting less than 20% down, and the premiums increase as the downpayments decrease. This coverage is intended to entice the lender to enter into the financing arrangement because in the case of borrower default, the insurance company will make the lender whole. There is a popular misconception that this insurance kicks in and starts making the mortgage payment when the borrower stops. This is NOT the case. This insurance does not benefit the borrower in anyway other than making the lender willing to enter into the higher risk venture with them.
Title Insurance: Required in every mortgage transaction. Insurance that covers the lender up to the mortgage amount, and typically covers the borrower up to the full purchase price (or approval value) of the property. This policy provides coverage to both parties against losses incurred by any previously undisclosed or discovered liens that may supercede their ownership of the property.
Underwriting: The process by which a the borrower’s credit worthiness and income stability are analyzed. The property is also reviewed for acceptability as collateral for the mortgage loan. This is the risk assessment phase of the mortgage process. The underwriting process may reveal certain debts that must be paid before the mortgage can be approved, or certain conditions that must be met to provide added confidence in the quality of the loan and the level of risk the lender is taking.
Pre Payment Penalty: A penalty fee assessed for repayment of too much of the principal balance before it is due according to the amortization schedule. These are rarely used these days.
ARM: Stands for Adjustable Rate Mortgage. These are mortgages that provide for an adjustment in the interest rate, and consequently the mortgage payment, at very specific times. The adjusted interest rate is intended to reflect the market conditions at the time, thus keeping it “in sync” with the market. The Mortgage Note and Rider of an ARM also outline how the interest rate is to be adjusted, how it’s calculated, what it’s based on and when it takes effect.
BiWeekly Mortgage: A mortgage where the payments are substantially less than one full monthly mortgage payment, but they are due twice a month. This product provides a way for the borrower to spread out their mortgage payment over the month, possibly coordinated with paydays. Plus, since each lesser principal amount is applied to the balance, the loan amortizes faster than a mortgage with one monthly payment. Over the life of the loan, this saves the borrower a substantial amount of interest expense.
Balloon Mortgage: A mortgage where the payment is calculated on a long term, but the loan is due to be paid in full in the short term. This requires normal mortgage payments for a specified period of time, then one last payment which includes the remaining balance of the mortgage to be paid in full—that would be the balloon. A balloon mortgage is basically a way for a borrower to get a lower long term payment, but the lender gets their money back on a short term loan.
Good Faith Estimate: A document provided by mortgage interviewer listing all costs involved in getting the mortgage, not just the lender’s fees. This is a very valuable document in that it provides an estimate of the total amount that it will cost to get the financing under a chosen plan.
APR: Stands for Annual Percentage Rate. This is basically the actual rate you’re paying to borrow that mortgage money. It factors in all other upfront expenses in addition to the regular monthly principal and interest payment to determine what the loan is really costing the borrower. To be honest, I don’t think too many people pay attention to it. It doesn’t have any impact on your monthly payment, and that’s what most people care about. It’s a regulatory requirement, and basically only for informational purposes.
LTV: Stands for Loan To Value. This is a ratio calculated by dividing the loan amount by the approval value of the subject property (typically the lesser of the appraised value or the sales price in a purchase situation, or the appraised value in a refinance scenario). Typically the higher the LTV, the greater risk the lender has in the deal and the more stringent the conditions of the financing may be. It often results in a higher interest rate to compensate the lender for the added risk.
Servicing: All functions related to the maintenance of a closed mortgatge loan from the time the loan closes until it is finally paid off. These functions include payment collections, delinquent collections, escrow payments, federal reporting requirements, etc. Servicing can be on either a released or retained basis. Retained servicing is when the originating lender does not release the servicing rights of the loan; they may still sell the loan asset itself, but they will continue to service the loan for the borrower and on behalf of their end investor. Servicing released is when the servicing rights are released along with the loan asset to the end investor. The originating lender has no further responsibility to the borrower once the servicing is released. Some lenders are aware that borrower's prefer to continue dealing with them as an entity they are familiar with and offer the option to retain the servicing; they typically charge an upfront fee to the borrower for this servicing arrangement, typically .25% or a quarter of a point.
Servicer: The company that will provide the customer service on the mortgage loan from closing until payoff. The servicer is responsible for collecting payments, providing year end tax documents on interest and taxes paid on all mortgage accounts, collecting delinquent payments, responding to customer inquiries, reporting and remitting to investors, collecting all escrow funds and subsequent payment of all escrow items (taxes, homeowners insurance premiums, etc.).
Investor: The entity that purchases the Mortgage Note and all rights, priviledges and responsibilities associated with the asset. It is the investor's guidelines that lenders follow in originating the mortgage loan, as they are basically originating the loan for the purpose of selling the end asset to that investor. The investor is usually, but not always, the servicer of the mortgage after purchase of the loan.
Teaser Rate: An initial interest rate deliberately set well below other mortgage products to entice borrowers. This rate ends with the first adjustment.
Index: The market indicator to which the interest rate is tied. Usually a treasury Note rate average published in the Wall Street Journal. The most common is the one year treasury average. A margin, or additional percentage spread, is added to this index to determine the new interest rate.
Margin: The additional percentage spread added to the Index to compose the new adjusted interest rate of an Adjustable Rate Mortgage.
Caps: The limit imposed on how much the interest rate can be changed, up or down, at any adjustment. This is incorporated into the adjustment mechanism to help avoid payment shock in times of wide fluctuations in interest rates. They are typically quoted as both per adjustment, which limits the adjustment at each change, and lifetime caps, which stipulate the absolute maximum any adjusted interest rate can be set from the initial interest rate. This provides a floor and ceiling to rate changes over the life of the loan.
