Financing Your Purchase

Some Basic Terminology

 

Most contracts for the purchase of real estate are contingent on the buyers ability to secure a mortgage. Knowing how much money you can afford to borrow and what it means to borrow money on a long term basis are important considerations.

Obtaining an affordable mortgage depends not only on what you feel you can afford, but, more importantly, on what a lending institution says you can afford. Before a lender will issue a commitment to lend large sums of money it must be assured that the buyer can afford to repay the loan, and that the value of the property is sufficient collateral to guarantee repayment of the loan in case the borrower defaults. Since financing can be a critical aspect of making an offer to purchase property, it can be helpful to consult with a lender prior to beginning your search for the right property. Pre-qualification for a mortgage will help you know what price range to look in and may also make your offer to purchase more acceptable. A seller is more likely to negotiate seriously when he or she knows that the offer is coming from someone who is financially qualified to purchase the property.

The basic definition of a mortgage is quite simple: a loan secured by real estate. But choosing the right mortgage from the myriad types available is anything but simple. The following represents only a partial listing of mortgage plans, but may help you make a more informed decision.

 

You may click any of the following terms to jump directly to the area in the Glossary where the subject is discussed.

 

Finance Terms
Adjustable Rate Mortgage (ARM)
Assumable Mortgage
Balloon Payment Mortgage
Buy-Down
Conventional Mortgage
FHA Mortgage
Fixed Rate Mortgage
Graduated Payment Mortgage (GPM)
Seller Take Back
VA Mortgage
Wraparound Mortgage
Other Considerations
Acceleration
Alienation Clause
Amortization
Application Fee
Appraisal
APR
Assumable
Buy-Down
Commitment Fee
Credit Report
Deed Of Trust
Default
Discount
Due on Sale Clause
Floating a Rate
Foreclosure
Late Charge
Locked in Rate
Mortgage
Note
Origination Fee
PITI
Point
Prepayment
Reinstatement
Release
Truth-in-Lending Disclosure
Underwriting
Adjustable Rate Terms
Adjustable Rate
Adjustment Period
CAP
Conversion
Index
Margin
Negative Amortization



Finance Terms

Adjustable Rate Mortgage (ARM)

A mortgage where the interest rate is subject to periodic adjustment, based on the movement of a pre-selected index

 

Assumable Mortgage

Sometimes seller’s existing mortgage can be taken over or assumed by the purchaser. The difference between the contract purchase price and the principal balance due on the existing loan is then paid in cash to the seller. Not all loans are assumable.

 

Balloon Payment Mortgage

A mortgage where payments are calculated on the basis of a long-term pay-back period, but which requires the unpaid principal balance to be paid in a lump sum at a specified time that is shorter than the term for calculating payments, i.e. a loan could be based on a 30-year amortization schedule, but require a balloon payment of the unpaid balance at the end of the fifth year.

 

Buy-Down

When the interest rate is reduced for a specified period of time by depositing a sum of money with the lender. The borrower’s mortgage payment during the “buy down” period is less than the payment that would be due under the terms of the mortgage. The lender offsets the deficit by drawing funds from the “buy down” fund in an amount equal to the difference between the borrower’s payment and the payment called for in the mortgage.

 

Conventional Mortgage

A mortgage that is not insured or guaranteed by any federal or state agency.

 

Fixed Rate Mortgage

A mortgage with an interest rate fixed for the entire term of the loan.

 

FHA Mortgage

A mortgage in which repayment is guaranteed by the Federal Housing Administration by virtue of its commitment to the lender.

 

Graduated Payment Mortgage (GPM)

A mortgage structured so that monthly payments are smaller the first few years of a loan. then rise according to a predetermined schedule. A GPM is designed to help first-time buyers purchase a home at a low initial carrying cost, then match rising carrying costs to rising earning power.

 

Seller Take Back

A situation in which the seller of a property agrees to take back, or hold a mortgage for all our any part of the buyers’ financing needs.

 

VA Mortgage

A mortgage where repayment is guaranteed by the Veterans’ Administration. Only qualified veterans are eligible for this type of loan.

 

Wraparound Mortgage

A hybrid loan where the borrower assumes an existing mortgage and also borrows additional funds, all in the format of a single new mortgage. The lender collects monthly payments which it then applies to the total loan, including payments on the assumed mortgage.

 

Other Considerations

Just as price should not be the only consideration in submitting an offer to purchase property, the rate of interest should not be the only concern when applying for a loan. While there may not be as much flexibility in negotiating a mortgage as there is in making a purchase offer, there are some terms and conditions in a mortgage commitment that are negotiable. Some items which may be negotiable include:

 

  • Will you be allowed to select your own attorney or title company to conduct settlement? If not, are there any additional fees you will be charged?

  • Will escrow accounts for taxes and insurance be optional or mandatory? If mandatory, will the lender pay interest on escrow balances?

  • How long will the lender extend its interest rate and loan commitment?

 

Questions such as these should be asked at the time of loan application. Once a loan commitment is issued, it may be too late to change any of its requirements.

 

To properly shop for and compare loan commitments, there is a certain vocabulary that you will need to learn. Some of the more important terms are:

 

Acceleration

A lender’s right to demand that a loan be paid in-full, prior to maturity, in the event a borrower breaches the terms of the loan document.

 

Alienation Clause

A lender’s right to demand that a loan he paid in-full, prior to maturity, if the title (ownership) of the property secured by the mortgage is transferred without the lender’s consent.

 

Amortization

Gradual reduction of indebtedness by a portion of each payment being applied to the principal.

 

Application Fee

A fee charged by some lenders for the processing of a loan application. The fee may or may not include the appraisal and credit report fee.

 

Appraisal

A written opinion stating the market value of a property according to a qualified appraiser. Such opinions are generally based on the sale of comparable properties in the same general vicinity and estimated replacement costs.

 

Assumable

A mortgage that is transferable from one property owner to another; or a loan that does not have to be paid off when the title to a property is conveyed to a new owner.

 

Buy-Down

Payment of a lump sum of money to the lender to reduce the interest for the life of the loan or for a stipulated period of time.

 

Commitment Fee

A fee collected by some lenders at the time a mortgage commitment is accepted by the borrower. Normally, this fee is non-refundable, but may be credited towards the “points” due at time of settlement.

 

Credit Report

A report ordered by a lender from a credit reporting bureau that will disclose a borrower’s payment history of existing credit accounts. The report is used to help evaluate a lender’s risk in extending credit to an applicant.

 

Deed Of Trust

A legal document whereby a borrower conveys the title of a property to trustees designated by the lender to secure the repayment of the money loaned.

 

Default

Failure of a buyer to comply with all the terms and conditions of the loan document, thereby giving the lender the right to call the loan due.

 

Discount

A sum of money, commonly referred to as points, paid to a lender for the purpose of securing a preferred interest rate for the term of the loan. Each point equals 1% of the loan amount.

 

Due on Sale Clause

Also called an alienation clause, this requires that a mortgage be paid in full prior to maturity if the title of the property is transferred without the lender’s consent.

 

Floating a Rate

A process in which the lender does not set the interest at the time of loan application, but lets it float in anticipation that the rate will go down prior to closing. The borrower then gets the benefit of the lower rate if rates do go down; however, if rates go up, then the borrower would pay the higher rate.

 

Foreclosure

Legal action taken by a lender after a default to recoup the unpaid principal due on the mortgage, the accrued interest and all costs associated with the collection process.

 

Late Charge

A fee charged by a lender when a mortgage payment is not received within a stipulated period of time. Generally, a payment is considered late if it is not received within 15 days of the due date.

 

Locked in Rate

A lender’s guarantee of a specific interest rate for a borrower. Whether the rate is locked in at time of application, loan commitment or just prior to closing is subject to negotiation.

 

Mortgage

A legal document whereby a borrower conveys the title of a property to the lender to secure the repayment of the money loaned.

 

Note

The written promise of a borrower to pay a named lender a definite sum of money at an agreed interest rate over a stipulated period of time.

 

Origination Fee

A fee charged by a lender to cover the cost of processing a loan application, generally 1% of the loan amount.

 

PITI

An abbreviation for a monthly mortgage payment. PI refers to the principal and interest portion of the payment. TI refers to taxes and insurance payments placed in escrow accounts.

 

Point

A fee paid to a lender in order to “buy” an interest rate. Each point is equal to 1% of the loan amount. The total charge will vary according to the type of loan and interest rate charged.

 

Prepayment

Payment of the principal balance in whole or in part prior to the maturity date agreed to in a mortgage.

 

Reinstatement

A defaulting borrower’s right to make up the missed payments, including late charges, and reinstate the balance of the payment schedule.

 

Release

A written acknowledgement by a lender that the debt has been paid off. If the debt is secured by a mortgage or deed of trust that has been recorded in the land records, then the release also must be recorded to clear the title to the property.

 

Truth-in-Lending Disclosure

The lender’s disclosure of the total cost of a loan if it lasts its full term. Part of this — APR Annual Percentage Rate — shows the costs as an Annualized Interest Rate that exceeds the agreed rate. The rate includes the note rate plus prepaid finance charges — origination fee, points, mortgage insurance premium — paid in advance by the borrower.

 

APR

A measure of the cost of credit expressed as a yearly rate. It includes interest as well as other charges paid in advance by the borrower.

 

Underwriting

The final step in the loan process. At this stage, all the information gathered as part of the application process — appraised value of property, condition of property, credit history, income and debts of applicant — is analyzed to determine if the property and applicant meet the lender’s criteria for a firm loan commitment.

 

Adjustable Rate Terms

Adjustable rate mortgages have additional terms which must be understood to make an accurate comparison of the numerous adjustable programs available today. Important terminology includes:

 

Adjustable Rate

The interest rate charged by the lender is subject to adjustment throughout the term of the loan.

 

Adjustment Period

The interval of time between interest rate adjustments; for a 1 year ARM, the adjustment period is every 12 months.

 

CAP

A limit on how much the interest rate can increase or decrease on any adjustment date or over the life of the loan.

 

Conversion

A provision in some ARM loans that allows the borrower to convert from an adjustable to a fixed rate of interest for the balance of the loan term.

 

Index

A financial standard that acts as the basis for establishing the periodic interest rate adjustments called for in the loan documents, i.e. 52-week Treasury bill index rates applicable to certificates auctioned by the U.S. Government having a maturity of one year.

 

Margin

The rate of interest added to the index rate to determine what the adjusted interest rate should be on the date specified for the rate change.

 

Negative Amortization

When the monthly payment agreed to by the borrower and lender is not sufficient to cover the cost of principal and interest, the amount of the monthly deficit is added to the unpaid principal balance, thereby causing the principal to exceed the amount originally borrowed.