The Importance of Financing
By Steve Gillman - 2004
Financing is the other half of affordable housing. It is nice
to get a great price on a home you like, but bad mortgage loans
can make cheap houses expensive. On the other hand, a good mortgage
interest rate with a proper amortization term can make your monthly
payments less than rent. So whether buying or refinancing, you
need to learn some of the basics of home finance.
Two other pages on financing:
Loan Pre-Approval
Mortgage Prepayment
Penalties
Educate Yourself about Financing
Check back in the future for more articles on the following
topics: Internet banks...ARM's vs. fixed-rate loans...points...loan
fees...no-doc and low-doc loans...land contracts and other seller
financing...second mortgages vs refinancing...loans with balloon
payments...interest-only loans...FHA, VA and other government-backed
loans...amortization (how it works)...15-year vs 30-year mortgage
loans...mortgage loan brokers...mortgage insurance...debt ratios...builder
down payment gift programs...LTV ratios...Freddie Mac and Fannie
Mae...pre-payment penalties...credit ratings and the cost of
bad credit...consolidation loans...wrap-around mortgages...nominal
vs effective interest rate...reverse amortization loans...loan
assumption and more.
Whatever you read here or elsewhere, keep in mind that the
business of home finance is continually changing. To educate
yourself and keep your knowledge up-to-date, talk to bankers,
mortgage loan brokers, and other professionals. You are never
obligated to do anything just by asking for information. Read
up on financing if you have time. Your education can save you
thousands. Finally, the glossary of terms below is a good place
to start.
Glossary Of Financing Terms
203(b): FHA program which provides mortgage insurance
to protect lenders from default; used to finance the purchase
of new or existing one- to four family housing; characterized
by low down payment, flexible qualifying guidelines, limited
fees, and a limit on maximum loan amount.
203(k): this FHA mortgage insurance program enables
home buyers to finance both the purchase of a house and the cost
of its rehabilitation through a single mortgage loan.
A
Amenity: a feature of the home or property that serves
as a benefit to the buyer but that is not necessary to its use;
may be natural (like location, Woods, water) or man-made (like
a swimming pool or garden).
Amortization: repayment of a mortgage loan through
monthly installments of principal and interest; the monthly payment
amount is based on a schedule that will allow you to own your
home at the end of a specific time period (for example, 15 or
30 years)
Annual Percentage Rate (APR): calculated by using a
standard formula, the APR shows the cost of a loan; expressed
as a yearly interest rate, it includes the interest, points,
mortgage insurance, and other fees associated with the loan.
Application: the first step in the official loan approval
process; this form is used to record important information about
the potential borrower necessary to the underwriting process.
Appraisal: a document that gives an estimate of a property's
fair market value; an appraisal is generally required by a lender
before loan approval to ensure that the mortgage loan amount
is not more than the value of the property.
Appraiser: a qualified individual who uses his or her
experience and knowledge to prepare the appraisal estimate.
ARM: Adjustable Rate Mortgage; a mortgage loan subject
to changes in interest rates; when rates change, ARM monthly
payments increase or decrease at intervals determined by the
lender; the Change in monthly -payment amount, however, is usually
subject to a Cap.
Assessor: a government official who is responsible
for determining the value of a property for the purpose of taxation.
Assumable mortgage: a mortgage that can be transferred
from a seller to a buyer; once the loan is assumed by the buyer
the seller is no longer responsible for repaying it; there may
be a fee and/or a credit package involved in the transfer of
an assumable mortgage.
B
Balloon Mortgage: a mortgage that typically offers
low rates for an initial period of time (usually 5, 7, or 10)
years; after that time period elapses, the balance is due or
is refinanced by the borrower.
Bankruptcy: a federal law Whereby a person's assets
are turned over to a trustee and used to pay off outstanding
debts; this usually occurs when someone owes more than they have
the ability to repay.
Borrower: a person who has been approved to receive
a loan and is then obligated to repay it and any additional fees
according to the loan terms.
Building code: based on agreed upon safety standards
within a specific area, a building code is a regulation that
determines the design, construction, and materials used in building.
Budget: a detailed record of all income earned and
spent during a specific period of time.
C
Cap: a limit, such as that placed on an adjustable
rate mortgage, on how much a monthly payment or interest rate
can increase or decrease.
Cash reserves: a cash amount sometimes required to
be held in reserve in addition to the down payment and closing
costs; the amount is determined by the lender.
Certificate of title: a document provided by a qualified
source (such as a title company) that shows the property legally
belongs to the current owner; before the title is transferred
at closing, it should be clear and free of all liens or other
claims.
Closing: also known as settlement, this is the time
at which the property is formally sold and transferred from the
seller to the buyer; it is at this time that the borrower takes
on the loan obligation, pays all closing costs, and receives
title from the seller.
Closing costs: customary costs above and beyond the
sale price of the property that must be paid to cover the transfer
of ownership at closing; these costs generally vary by geographic
location and are typically detailed to the borrower after submission
of a loan application.
Commission: an amount, usually a percentage of the
property sales price, that is collected by a real estate professional
as a fee for negotiating the transaction..
Condominium: a form of ownership in which individuals
purchase and own a unit of housing in a multi-unit complex; the
owner also shares financial responsibility for common areas.
Conventional loan: a private sector loan, one that
is not guaranteed or insured by the U.S. government.
Cooperative (Co-op): residents purchase stock in a
cooperative corporation that owns a structure; each stockholder
is then entitled to live in a specific unit of the structure
and is responsible for paying a portion of the loan.
Credit history: history of an individual's debt payment;
lenders use this information to gouge a potential borrower's
ability to repay a loan.
Credit report: a record that lists all past and present
debts and the timeliness of their repayment; it documents an
individual's credit history.
Credit bureau score: a number representing the possibility
a borrower may default; it is based upon credit history and is
used to determine ability to qualify for a mortgage loan.
D
Debt-to-income ratio: a comparison of gross income
to housing and non-housing expenses; With the FHA, the-monthly
mortgage payment should be no more than 29% of monthly gross
income (before taxes) and the mortgage payment combined with
non-housing debts should not exceed 41% of income.
Deed: the document that transfers ownership of a property.
Deed-in-lieu: to avoid foreclosure ("in lieu"
of foreclosure), a deed is given to the lender to fulfill the
obligation to repay the debt; this process doesn't allow the
borrower to remain in the house but helps avoid the costs, time,
and effort associated with foreclosure.
Default: the inability to pay monthly mortgage payments
in a timely manner or to otherwise meet the mortgage terms.
Delinquency: failure of a borrower to make timely mortgage
payments under a loan agreement.
Discount point: normally paid at closing and generally
calculated to be equivalent to 1% of the total loan amount, discount
points are paid to reduce the interest rate on a loan.
Down payment: the portion of a home's purchase price
that is paid in cash and is not part of the mortgage loan.
E
Earnest money: money put down by a potential buyer
to show that he or she is serious about purchasing the home;
it becomes part of the down payment if the offer is accepted,
is returned if the offer is rejected, or is forfeited if the
buyer pulls out of the deal.
EEM: Energy Efficient Mortgage; an FHA program that
helps home buyers save money on utility bills by enabling them
to finance the cost of adding energy efficiency features to a
new or existing home as part of the home purchase
Equity: an owner's financial interest in a property; calculated
by subtracting the amount still owed on the mortgage loon(s)from
the fair market value of the property.
Escrow account: a separate account into which the lender
puts a portion of each monthly mortgage payment; an escrow account
provides the funds needed for such expenses as property taxes,
homeowners insurance, mortgage insurance, etc.
F
Fair Housing Act: a law that prohibits discrimination
in all facets of the home buying process on the basis of race,
color, national origin, religion, sex, familial status, or disability.
Fair market value: the hypothetical price that a willing
buyer and seller will agree upon when they are acting freely,
carefully, and with complete knowledge of the situation.
Fannie Mae: Federal National Mortgage Association (FNMA);
a federally-chartered enterprise owned by private stockholders
that purchases residential mortgages and converts them into securities
for sale to investors; by purchasing mortgages, Fannie Mae supplies
funds that lenders may loan to potential home buyers.
FHA: Federal Housing Administration; established in
1934 to advance home ownership opportunities for all Americans;
assists home buyers by providing mortgage insurance to lenders
to cover most losses that may occur when a borrower defaults;
this encourages lenders to make loans to borrowers who might
not qualify for conventional mortgages.
Fixed-rate mortgage: a mortgage with payments that
remain the same throughout the life of the loan because the interest
rate and other terms are fixed and do not change.
Flood insurance: insurance that protects homeowners
against losses from a flood; if a home is located in a flood
plain, the lender will require flood insurance before approving
a loan.
Foreclosure: a legal process in which mortgaged property
is sold to pay the loan of the defaulting borrower.
Freddie Mac: Federal Home Loan Mortgage Corporation
(FHLM); a federally-chartered corporation that purchases residential
mortgages, securitizes them, and sells them to investors; this
provides lenders With funds for new home buyers.
G
Ginnie Mae: Government National Mortgage Association
(GNMA); a government-owned corporation overseen by the U.S. Department
of Housing and Urban Development, Ginnie Mae pools FHA-insured
and VA-guaranteed loans to back securities for private investment;
as With Fannie Mae and Freddie Mac, the investment income provides
funding that may then be lent to eligible borrowers by lenders.
Good faith estimate: an estimate of all closing fees
including pre-paid and escrow items as well as lender charges;
must be given to the borrower within three days after submission
of a loan application.
H
HELP: Home buyer Education Learning Program; an educational
program from the FHA that counsels people about the homebuying
process; HELP covers topics like budgeting, finding a home, getting
a loan, and home maintenance; in most cases, completion of the
program may entitle the homebuyer to a reduced initial FHA mortgage
insurance premium-from 2.25% to 1.75% of the home purchase price.
Home inspection: an examination of the structure and
mechanical systems to determine a home's safety; makes the potential
homebuyer aware of any repairs that may be needed.
Home warranty: offers protection for mechanical systems
and attached appliances against unexpected repairs not covered
by homeowner's insurance; ,overage extends over a specific time
period and does not cover the home's structure.
Homeowner's insurance: an insurance policy that .combines
protection against damage to a dwelling and Is contents with
protection against claims of negligence )r inappropriate action
that result in someone's injury or )property damage.
Housing counseling agency: provides counseling and
assistance to individuals on a variety of issues, including loan
default, fair housing, and homebuying.
HUD: the U.S. Department of Housing and Urban Development;
established in 1965, HUD works to create a decent home and suitable
living environment for all Americans; it does this by addressing
housing needs, improving and developing American communities,
and enforcing fair housing laws.
HUD1 Statement: also known as the "settlement
sheet," it itemizes all closing costs; must be given to
the borrower at or before closing.
HVAC: Heating, Ventilation and Air Conditioning; a
home's heating and cooling system.
I
Index: a measurement used by lenders to determine changes
to the Interest rate charged on an adjustable rate mortgage.
Inflation: the number of dollars in circulation exceeds
the amount of goods and services available for purchase; inflation
results in a decrease in the dollar's value.
Interest: a fee charged for the use of money .
Interest rate: the amount of interest charged on a
monthly loan payment; usually expressed as a percentage.
Insurance: protection against a specific loss over
a period of time that is secured by the payment of a regularly
scheduled premium.
J
Judgment: a legal decision; when requiring debt repayment,
a judgment may include a property lien that secures the creditor's
claim by providing a collateral source.
L
Lease purchase: assists low- to moderate-income homebuyers
in purchasing a home by allowing them to lease a home with an
option to buy; the rent payment is made up of the monthly rental
payment plus an additional amount that is credited to an account
for use as a down payment.
Lien: a legal claim against property that must be satisfied
When the property is sold
Loan: money borrowed that is usually repaid with interest.
Loan fraud: purposely giving incorrect information
on a loan application in order to better qualify for a loan;
may result in civil liability or criminal penalties.
Loan-to-value (LTV) ratio: a percentage calculated
by dividing the amount borrowed by the price or appraised value
of the home to be purchased; the higher the LTV, the less cash
a borrower is required to pay as down payment.
Lock-in: since interest rates can change frequently,
many lenders offer an interest rate lock-in that guarantees a
specific interest rate if the loan is closed within a specific
time.
Loss mitigation: a process to avoid foreclosure; the
lender tries to help a borrower who has been unable to make loan
payments and is in danger of defaulting on his or her loan
M
Margin: an amount the lender adds to an index to determine
the interest rate on an adjustable rate mortgage.
Mortgage: a lien on the property that secures the Promise
to repay a loan.
Mortgage banker: a company that originates loans and
resells them to secondary mortgage lenders like :Fannie Mae or
Freddie Mac.
Mortgage broker: a firm that originates and processes
loans for a number of lenders.
Mortgage insurance: a policy that protects lenders
against some or most of the losses that can occur when a borrower
defaults on a mortgage loan; mortgage insurance is required primarily
for borrowers with a down payment of less than 20% of the home's
purchase price.
Mortgage insurance premium (MIP): a monthly payment
-usually part of the mortgage payment - paid by a borrower for
mortgage insurance.
Mortgage Modification: a loss mitigation option that
allows a borrower to refinance and/or extend the term of the
mortgage loan and thus reduce the monthly payments.
O
Offer: indication by a potential buyer of a willingness
to purchase a home at a specific price; generally put forth in
writing.
Origination: the process of preparing, submitting,
and evaluating a loan application; generally includes a credit
check, verification of employment, and a property appraisal.
Origination fee: the charge for originating a loan;
is usually calculated in the form of points and paid at closing.
P
Partial Claim: a loss mitigation option offered by
the FHA that allows a borrower, with help from a lender, to get
an interest-free loan from HUD to bring their mortgage payments
up to date.
PITI: Principal, Interest, Taxes, and Insurance - the
four elements of a monthly mortgage payment; payments of principal
and interest go directly towards repaying the loan while the
portion that covers taxes and insurance (homeowner's and mortgage,
if applicable) goes into an escrow account to cover the fees
when they are due.
PMI: Private Mortgage Insurance; privately-owned companies
that offer standard and special affordable mortgage insurance
programs for qualified borrowers with down payments of less than
20% of a purchase price.
Pre-approve: lender commits to lend to a potential
borrower; commitment remains as long as the borrower still meets
the qualification requirements at the time of purchase.
Pre-foreclosure sale: allows a defaulting borrower
to sell the mortgaged property to satisfy the loan and avoid
foreclosure.
Pre-qualify: a lender informally determines the maximum
amount an individual is eligible to borrow.
Premium: an amount paid on a regular schedule by a
policyholder that maintains insurance coverage.
Prepayment: payment of the mortgage loan before the
scheduled due date; may be Subject to a prepayment penalty.
Principal: the amount borrowed from a lender; doesn't
include interest or additional fees.
R
Radon: a radioactive gas found in some homes that,
if occurring in strong enough concentrations, can cause health
problems.
Real estate agent: an individual who is licensed to
negotiate and arrange real estate sales; works for a real estate
broker.
REALTOR: a real estate agent or broker who is a member
of the NATIONAL ASSOCIATION OF REALTORS, and its local and state
associations.
Refinancing: paying off one loan by obtaining another;
refinancing is generally done to secure better loan terms (like
a lower interest rate).
Rehabilitation mortgage: a mortgage that covers the
costs of rehabilitating (repairing or Improving) a property;
some rehabilitation mortgages - like the FHA's 203(k) - allow
a borrower to roll the costs of rehabilitation and home purchase
into one mortgage loan.
RESPA: Real Estate Settlement Procedures Act; a law
protecting consumers from abuses during the residential real
estate purchase and loan process by requiring lenders to disclose
all settlement costs, practices, and relationships
S
Settlement: another name for closing .
Special Forbearance: a loss mitigation option where
the lender arranges a revised repayment plan for the borrower
that may include a temporary reduction or suspension of monthly
loan payments.
Subordinate: to place in a rank of lesser importance
or to make one claim secondary to another.
Survey: a property diagram that indicates legal boundaries,
easements, encroachments, rights of way, improvement locations,
etc.
Sweat equity: using labor to build or improve a property
as part of the down payment
T
Title 1: an FHA-insured loan that allows a borrower
to make non-luxury improvements (like renovations or repairs)
to their home; Title I loans less than $7,500 don't require a
property lien.
Title insurance: insurance that protects the lender
against any claims that arise from arguments about ownership
of the property; also available for homebuyers.
Title search: a check of public records to be sure
that the seller is the recognized owner of the real estate and
that there are no unsettled liens or other claims against the
property.
Truth-in-Lending: a federal law obligating a lender
to give fuII written disclosure of aII fees, terms, and conditions
associated with the loan initial period and then adjusts to another
rate that lasts for the term of the loan.
U
Underwriting: the process of analyzing a loan application
to determine the amount of risk involved in making the loan;
it includes a review of the potential borrower's credit history
and a judgment of the property value.
V
VA: Department of Veterans Affairs: a federal agency
which guarantees loans made to veterans; similar to mortgage
insurance, a loan guarantee protects lenders against loss that
may result from a borrower default.
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