Fundamental Mortgage Terms

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adjustable-rate mortgage (ARM): a loan with an interest rate and payment that change periodically based on a predetermined index. The ARM is the most popular form of alternative mortgage instrument and is also known as a variable-rate or flexible-rate mortgage.

alternative mortgage instrument: a type of mortgage not based on a constant interest rate.

amortization: the process of paying off a loan gradually and by periodic payments. An amortization schedule shows how much of each payment will be applied toward both principal and interest over the life of the loan as well as the gradual decrease of the loan balance.

appraisal: a written opinion of the value of a property, primarily based on an analysis of comparable properties in the area.

balloon mortgage: a mortgage loan that requires the remaining principal balance be paid at a specific point before the end of the loan term.

biweekly mortgage: a mortgage loan on which the borrower pays half the monthly payment every two weeks. The payment is calculated on an amortization schedule based on 26 biweekly payments during the year. This results in the equivalent of 13 monthly payments rather than 12. Because of the extra payment, the mortgage amortizes before term, making this a popular way for homeowners to shorten the life of their debt.

closing costs: costs that the borrower must pay at the time of closing in addition to the down payment (loan origination fee, appraisal fee, etc.).

commercial loan: a mortgage loan on property that produces income.

construction loan: a short-term loan to finance the cost of construction. The lender makes payments to the builder in stages as the work progresses.

conventional mortgage: a mortgage loan that is not insured or guaranteed by the federal government.

convertible ARM: an adjustable-rate mortgage that allows the borrower to change the loan to a fixed-rate mortgage within a specific time.

credit history: a record of an individual’s repayment of debt.

credit scoring: a process that uses recorded information about individuals and their loan requests to assess future performance regarding debt repayment.

default: failure to make mortgage payments within a specified period of time (e.g., within 30 days of the due date).

delinquency: failure to make mortgage payments when they are due.

down payment: the portion of the purchase price of a property that a buyer pays in cash and does not finance with a mortgage loan.

earnest money: funds a buyer gives with an offer to purchase a property to show that he or she is serious.

equity: the difference between the fair market value of a property and the amount still owed on it.

escrow: a neutral third party that holds the documents, money, or other items of value involved in a real estate transaction and ensures that all conditions of a sale are met (for example, earnest money is put into escrow until it is delivered to the seller at closing). Escrow also refers to a special account that a lender establishes to hold monthly installments from the borrower to cover property taxes and insurance.

Fair Credit Reporting Act: a federal consumer protection law passed in 1971 that regulates the activity of credit bureaus, including the disclosure of consumer credit reports and procedures for correcting mistakes on credit records.

Fannie Mae: the Federal National Mortgage Association (FNMA), the nation’s largest supplier of home mortgage funds. Fannie Mae is a congressionally chartered, shareholder-owned company that purchases loans from lenders and resells them.

FHA: the Federal Housing Administration, created by Congress in 1934. This division of U.S. Department of Housing and Urban Development (HUD) insures residential mortgage loans made by approved private lenders and sets standards for construction and underwriting.

fixed-rate mortgage: a standard loan with a set interest rate amortized for a fixed amount of time. Equal monthly payments for the term of the loan pay interest on the loan due since the last payment, and the remainder of the payment is used to reduce the principle. A 30-year fixed-rate mortgage is amortized over 30 years (360 payments), and a 15-year fixed-rate mortgage is amortized over 15 years (180 payments).

foreclosure: the legal process by which property that is mortgaged may be sold to pay a defaulting borrower's loan.

Freddie Mac: the Federal Home Loan Mortgage Corporation (FHLMC), a congressionally chartered agency that purchases conventional first mortgages and secondary mortgages guaranteed by the FHA or VA and resells them.

Ginnie Mae: the Government National Mortgage Association (GNMA), a government-owned corporation created by Congress as part of HUD. Ginnie Mae provides funds for government-backed loans (i.e., FHA and VA).

Home Equity Line of Credit (HELOC): a mortgage set up as a line of credit against which the borrower can draw up to an established maximum (as opposed to a loan for a fixed amount) over a certain period of time. As with the adjustable-rate mortgage, the interest rate for a HELOC adjusts to a predetermined index. Because the balance of a HELOC may change from day to day, depending on draws and repayments, interest is typically calculated daily.

HUD: the Department of Housing and Urban Development, established by the Housing and Urban Development Act of 1965. HUD's mission is to increase home ownership, support community development, and increase access to affordable housing free from discrimination.

indexes: financial tables used by lenders to calculate interest rates on adjustable mortgages.

interest-only mortgage: a loan in which the borrower pays only the interest that accrues on the balance each month; the principal balance of the loan, therefore, does not decrease with each payment.

interest rate cap: a limit on the amount of interest that can be applied to the monthly payment of an adjustable-rate mortgage during an adjustment period.

interest rate ceiling: the highest interest a lender can charge for an adjustable-rate mortgage.

jumbo mortgage: a mortgage loan for an amount larger than the maximum eligible for purchase by Fannie Mae and Freddie Mac. Some lenders use the term to refer to larger loans, such as those for amounts greater than $500,000.

lien: a legal claim (such as a mortgage) against a property that must be paid off when the property is sold.

lock-in: an agreement in which a lender guarantees a specified interest rate for a certain amount of time.

maturity: the date on which the principal balance of a loan becomes due and payable.

mortgage insurance: insurance that covers a lender against losses incurred as a result of default on a loan.

negative amortization: a situation in which a borrower's monthly payment is not large enough to cover both principal and interest due. As a result, the outstanding balance of the loan grows larger with each payment. Many adjustable-rate mortgages are susceptible to negative amortization.

non-owner-occupied property (investment property): one to four units, secured by a mortgage and not occupied by the borrower.

origination fee: a fee, calculated in points, charged by most lenders for processing a loan.

point: one percent of a loan amount.

PITI: principal, interest, taxes and insurance—the four components of a monthly payment to a lender.

prequalification: a process in which a lender examines a potential borrower’s credit, verifies his or her income, and agrees in writing that the borrower would be able to obtain a loan up to a certain amount.

prime rate: the interest rate banks charge their preferred customers.

principal: the amount borrowed or as-yet unpaid.

purchase agreement: a written contract signed by the buyer and seller stating the terms and conditions under which a property will be sold.

right of survivorship: in joint tenancy, the right of a survivor to acquire the interest of a deceased tenant.

second mortgage: a loan in addition and subordinate to a first mortgage.

title: a legal document indicating a person's right to or ownership of a property.

title company: a company that specializes in examining and insuring titles to real estate.

title insurance: insurance that protects a lender or buyer against loss arising from disputes over ownership of a property.

title search: an examination of title records to ensure that a seller is the legal owner of a property and that there are no liens or other claims on the property.

Truth-in-Lending: a federal law that requires lenders to fully disclose, in writing, the terms and conditions of a mortgage, including the annual percentage rate (APR) and other charges.

VA: the Veterans Administration. The Servicemen’s Readjustment Act of 1944 authorized this agency to administer a variety of benefit programs designed to facilitate the adjustment of returning veterans to civilian life. The VA Home Loan Guaranty Program is designed to encourage lenders to offer long-term, low-down-payment mortgages to eligible veterans by guaranteeing the lender against loss.

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