Some Common Mortgage Loan and Finance Terms Explained
The common terms used to describe a mortgage involve the "creditor," the "debtor," and "mortgage broker." It may be self-explanatory as to what those terms mean, but there are other terms involved with a mortgage as well that a homeowner may not be completely familiar with. Let's cover some of them here: Creditor The creditor is the financial institution, typically a bank, who provides the money in the form of a loan for the mortgage amount. The creditor is sometimes referred to as the mortgagee or lender. Debtor The debtor is the person or party who owes the mortgage or the loan. They may be referred to as the mortgagor. Many homes are owned by more than one person, such as a husband and wife, or sometimes two close friends will purchase a home together, or a child with their parent, and so on. If this is the case, both persons become debtors for that loan, and not just owners of the property. In other words, be careful of having your name put on the deed or title to any house, as this makes you legally responsible for the mortgage or loan attached to that house as well. Mortgage broker, financial advisor Mortgages are not always easy to come by, however, because of the demand for homes in most countries, there are many financial institutions that offer them. Banks, credit unions, Savings & Loan, and other types of institutions may offer mortgages. A mortgage broker can be used by the prospective debtor to find the best mortgage at the lowest interest rate for them; the mortgage broker also acts as an agent of the lender to find persons willing to take on these mortgages, to handle the paperwork, etc. There are typically other parties involved in closing or obtaining a mortgage, from lawyers to financial advisors. Because a mortgage for a private home is typically the largest debt that any one person will have over the course of his or her life, they often seek out whatever legal and financial advice is available to them in order to make the right decision. A financial advisor is someone who can become very familiar with your own particular needs, income, long-term goals, etc., and then give you the best advice on what your loan needs may be. Foreclosure When the debtor cannot or does not meet the financial obligations of the mortgage, the property can be foreclosed on, meaning that the creditor seizes the property to recoup the remaining cost of the loan. Typically, a home that is foreclosed upon will be sold at auction and that sale price applied to the outstanding amount of the mortgage; the debtor may still be liable for the remaining amount if the property sold for less than the outstanding balance of the mortgage. For example, suppose a person still owes $50,000 toward their mortgage, and their home is foreclosed. At auction, the home is sold for only $45,000. The debtor is still responsible for that remaining $5,000 difference. Most banks and financial institutions will try to avoid foreclosing on any of their debtor's property if at all possible. Not only do they run the risk of not being able to sell the home at auction for any price, but there are also additional costs and risks incurred when the home is vacated by the previous owners. This includes vandalism, squatters (persons who trespass onto vacant land or into vacant homes and stay there until forcibly removed), fines from cities for unkempt yards, and so on. Annual Percentage Rate (APR) The APR is not to be confused with a mortgage's interest rate. The APR is a loan's interest rate plus the added costs of obtaining the loan, such as points, origination fees, and mortgage insurance premiums (if applicable). If there were no costs involved in obtaining a loan other than the interest rate, the APR would then equal the interest rate. Breakeven Point The breakeven point is the length of time it will take to recover the costs incurred to refinance a mortgage. It is calculated by dividing the amount of closing costs for refinancing by the difference between the old and new monthly payment. For example, if it costs you $5,000 in fees, penalties, etc., to refinance your mortgage, but you save $300 per month on your payments with your new mortgage, the break-even point is after 17 months (17 months x $300 per month = $5,100). ARM This refers to an Adjustable Rate Mortgage; a mortgage that permits the lender to adjust its interest rate periodically. Fixed-Rate Mortgage A mortgage in which the interest rate does not change during the term of the loan. Cap ARMs have fluctuating interest rates, but those fluctuations are usually limited by law to a certain amount. Those limitations may apply to how much the loan may adjust over a six month period, an annual period, and over the life of the loan, and are referred to as "caps." Index A number used to compute the interest rate for an ARM. The index is generally a published number or percentage, such as the average interest rate or yield on U.S. Treasury Bills. A margin is added to the index to determine the interest rate that will be charged on the ARM. Since the index may vary with ARMs, many people considering refinancing do well to keep aware of the standard interest rate as set by the federal government, as this is typically used by lending institutions to calculate that index. Prime Rate The interest rate that banks charge to their preferred customers. Changes in the prime rate influence changes in other rates, including mortgage interest rates. Equity A homeowner's financial interest in or value of a property. Equity is the difference between the fair market value of the property and the amount still owed on its mortgage and other liens, if that value is higher. In other words, if the fair market value of the home is $200,000, and your mortgage (and other liens, if applicable) is only $150,000, then the home has $50,000 in equity. Home Equity Loan Loans secured by a specific property that were made against the "equity" of the property after it was purchased. Using the illustration above of a home that has $50,000 in equity, a homeowner may take out a loan up to that amount, using the home as collateral for that loan. A lending institution knows that if the homeowner defaults on the loan, they can seize the property and sell it for at least that much, getting back their loan amount. Amortization The gradual repayment of a mortgage loan, usually by monthly installments of principal and interest. An amortization table shows the payment amount broken out by interest, principal, and unpaid balance for the entire term of the loan. These tables are useful because when a payment is made toward a mortgage, the same amount does not get applied to the principal and interest month after month, even when the payment amount is the same. This is often a difficult concept for those not in the real estate or banking business to understand, so an amortization table that spells out how each payment is applied to the debt over the life of the loan can be very helpful. Cash-Out Refinance When a borrower refinances his mortgage at a higher amount than the current loan balance with the intention of pulling out money for personal use, it is referred to as a "cash out refinance." In other words, the mortgage is not simply for the home itself but an additional amount of money is being financed as well. Appraised Value An opinion of a property's fair market value, based on an appraiser's knowledge, experience, and analysis of the property. The appraised value of the home is a key factor in how much the home can or will be mortgaged for. Appreciation The increase in the value of a property due to changes in market conditions, inflation, or other causes. Depreciation A decline in the value of property; the opposite of appreciation. Appreciation and depreciation are important concepts to remember; as we've just mentioned, the appraised value of the home is a determining factor in the home's mortgage. When refinancing, it's important to understand that your home may have appreciated or depreciated in value since the original or first mortgage was obtained. Lock-in An agreement in which the lender guarantees a specified interest rate for a certain amount of time at a certain cost. Lock-in Period The time period during which the lender has guaranteed an interest rate to a borrower. This is a different concept than a fixed rate mortgage, as the lock-in period for a mortgage may be temporary rather than over the life of the loan. As we said previously, many of these terms you may already be familiar with, but it doesn't hurt to review them and see how they are all tied in together with your mortgage and the refinancing process. So now that you have these basic terms in mind when it comes to a mortgage and the lending process, let's discuss the process of refinancing in greater detail.
