A Glossary of Common Terms Used in Loans and Lending

by Ed Wachsman
  This article is reprinted here with permission from Creative Real Estate Online at http://www.creonline.com

This is a glossary of common terms used in loans and lending. Please note that some of these terms may also have other meanings in other real estate related contexts.

Editor's Note: This Glossary is a great resource, especially for beginners. It is lengthy, so please feel free to print a copy for your own use.

1003 Application. A loan application that is thorough and required for conforming loans. It has become the standard application for most residential loans, even non-conforming loans. (see definition of "conforming" below)

Acceleration. The act of a lender declaring a note immediately due and payable before the maturity date. The right to take this action is triggered by some violation of the terms of the loan.

Adjustable Rate Mortgage (ARM). A mortgage loan having an interest rate that can be raised or lowered over time based on periodic changes in a monitored index . (See definition of "index" below.)

Amortized Loan. A loan that is repaid in a series of installments each of which contains a portion that is applied to reduce the principal amount of the loan and a portion that is applied to pay interest. As time goes on, each successive payment allocates a larger portion to principal reduction and a smaller portion to interest payment until the outstanding balance is ultimately reduced to zero. If the loan has a fixed rate of interest, each payment is the same dollar amount throughout the course of the loan. If the loan has an adjustable rate of interest, each payment at each particular interest rate is the same dollar amount. For example, while the interest is 8.0%, all of the payments on a $100,000 loan for 30 years will be $733.77. If the interest rate changes to 9.0%, all of the payments will be $804.62 while the rate remains at the 9.0% rate.

Annual Cap. The maximum amount the interest rate on an adjustable rate mortgage can be raised or lowered in the course of one twelve month period. If the interest rate at the start of the period is 8.0% and the Annual Cap is 2.0% the interest will be adjusted no higher than to 10.0% during that period even if the index rises over 2.0%. (see definition of "index" below)

Annual Percentage Rate (APR). A more precise description of the cost of money which reflects not only the actual interest rate but also the cost of certain expenses charged as part of the process of obtaining the loan. The actual items that must be calculated into the APR are determined by the Federal government. If the interest rate on a loan was 8.0%, the APR would typically be somewhere around 8.3% - 9.0% depending upon what fees were charged and the amount of each fee.

Appraised Value. There are several types of appraisal depending on the goal. Values determined for insurance purposes typically reflect replacement cost of the improvements. Values needed for multi-unit and commercial real estate are primarily based on the net operating income (or the potential net operating income) of the property. Values needed for residential real estate are usually determined on the basis of comparable sales. (See the definitions of comparable sales and net operating income below and see J. P. Vaughan's article "What Is Market Value" in the How-To section of this site.)

Assumable Mortgage. An existing mortgage which allows the next purchaser of a property to be liable for the payments and other obligations of the note and mortgage. Depending on the type of loan, the assumption of the obligation by this next purchaser may or may not require a qualification and approval process and may or may not release the original mortgagor (borrower) from further liability. A written release from the mortgagee (lender) is required to relieve the original mortgagor of responsibility. Without a release, the original mortgagor must make the payments (and suffer harm to a credit report if they are not made) if the person assuming the mortgage fails to do so.

Balance. The outstanding dollar amount owed on a loan. Also referred to as loan balance or mortgage balance.

Balloon Payment. An installment payment which is larger (most often much larger) than the other scheduled payments. It is usually the last payment. If a note is written for $50,000 at a fixed 9.0% rate of interest with payments based on an amortization schedule of 30 years and a balloon payment due in 5 years, the first 60 payments will each be $402.31 (the normal payment for a 30 year loan at 9.0% interest) and the last payment will be $47,940.15 which will be the outstanding balance remaining after the 60th payment.

Blanket Mortgage. A single mortgage which attaches to more than one property. (See definition of "mortgage" below.)

Broker. An individual who acts as an intermediary between two or more parties for the purpose of negotiating a transaction agreeable to all of the parties. In lending, the broker arranges and negotiates loan amounts, interest rates and loan terms between borrowers and lenders. Depending on the type of loan, the state wherein the transaction is occurring and contractual arrangements, the broker may represent the borrower, the lender or not have a fiduciary responsibility to either. (See definition of "fiduciary responsibility" below.)

Buy Down. A payment of discounts points in exchange for a lower rate of interest. It has the effect of providing the lender with a greater yield today in exchange for a lower yield in the future. (See definition of "discount points" below.)

Cash Flow. The net operating income minus the total of all debt service payments. (See definition of "net operating income" below.)

Cash Out. Cash given to the borrower from the proceeds of a loan. While relatively common as part of a refinance, it is uncommon, but not impossible, as a benefit of a small percentage of non-conforming loans used for a purchase.

Closing. The formal meeting where loan documents are signed and funds disbursed. Note, however, that Federal law requires that funds not be disbursed for three business days on certain loans where personal residences serve as the security. (See definition of "rescission" below.)

Closing Costs. The expenses which borrowers incur to complete the loan transaction. These costs may include title searches, title insurance, closing fees, recording fees, processing fees and other charges.

Combined Loan-to-Value (CLTV). The total of all loans relative to the value of the property. If a property has a value of $100,000 and three loans totaling $125,000, the CLTV is 125% ($125,000 / $100,000).

Commitment. The notification that a lender has approved a loan. Virtually all commitments are issued conditionally; that is, subject to some list of conditions that must be satisfied prior to funding actually taking place. Typical conditions include appraisals of a certain value, clean title, verification of representations by the borrower, etc.

Comparable Sales. As part of the appraisal process, those relatively recently sold properties which will be compared to the subject property (the property being appraised) for the purpose of forming an opinion of value for the subject property. The facts and details of the comparable properties will be compared to those of the subject. In an urban setting, to be of credible assistance in this process, comparable sales must have the same use as the subject, have many similarities to the subject in terms of size of house, size of lot, construction, bedroom count, room count, floor plan, amenities, street traffic and be in the same neighborhood and have been sold in the recent past (preferably no more than six months) by way of an "arms length" transaction (i.e., not sold to a relative or friend and not sold due to a forced sale or distress sale) and be within one mile of the subject property. More liberal standards will apply for rural property and some suburban properties but the basic premise holds, the more similar the comparable sales are to the subject property, the more accurate the value assigned to the subject property will be. Lenders will often compensate for the less precise nature of rural appraised values by allowing only lower loan-to-value ratios than those in urban settings, usually 10% lower. (See definition of "loan-to-value" below.)

Conforming Loan. A loan which has underwriting criteria consistent with (i.e., conforming to) those strict guidelines of Fannie Mae, Freddie Mac, FHA or VA. These are typically the lowest interest rate loans with very good terms. (See definitions of "Fannie Mae", "Freddie Mac", "FHA", "VA" and "underwriting" below.)

Conventional Loan. A conforming loan with no government guarantee; that is, a Fannie Mae or Freddie Mac loan. (See definition of "conforming loan" above.)

Credit Line. A loan that allows revolving use of the credit; that is, after funds have been borrowed and repaid they may be borrowed again without applying for a new loan. Typically, a credit limit is established and some or all of the available funds can be optionally disbursed at closing. Undisbursed funds are available for the borrowers use at any time. Payments are required only on the outstanding balance. They are similar in use to a credit card except that they typically use checks to access the funds. They are inexpensive, effective tools for investors.

Debt Ratio (DR, D:I). Also known as debt to income. The ratio of the total of minimum monthly debt payments to gross monthly income. If minimum monthly payments on a credit card, auto lease, and mortgage (PITI) were $30, $220 and $750 respectively and the gross monthly income was $3000, the debt ratio would be 33.33% ($1000 / $3000). Only debt obligations that will be in place after the loan has funded are considered. Payments for food, utilities, entertainment, medical bills, etc. are not included in the calculation. Contractual obligations for rent (e.g., a lease) would be included in the calculation. The housing ratio in this example would be 25.0% ($750 / $3000).

The preferred candidate for conventional loans typically would have debt ratios of 28% for housing and 36% for the total with the maximum ratios allowed (on a case by case basis with compensating factors; i.e., some other strong positive to offset the negative of the higher debt ratio) being around 30% / 40% (housing / total). FHA and VA loans allow a total of approximately 41.0%. Non-conforming loans may allow total debt ratios as high as 55% or so. True "hard money" loans seldom consider debt ratios. (see definitions of "PITI", "Housing Ratio", "Non-conforming Loan" below)

Debt Coverage Ratio (DCR). A ratio used in underwriting loans for income producing property which is created by dividing net operating income by total debt service. Ratios of at least 1.10 are generally required with ratios of 1.20 and higher considered the norm. (See definition of "underwriting" below.)

Deed of Trust (DOT). DOT's are similar to mortgages in that they serve as security for a loan by encumbering real estate. However, a mortgage is between two parties (borrower and lender) and a deed of trust involves three parties (borrower, lender and trustee). The trustee holds the property in trust as security for the payment of the debt and can sell the property if the borrower defaults.

Default. Failure to meet all of the commitments and obligations specified in the mortgage or deed of trust. Defaults usually give the lender the right to accelerate payments and start foreclosure.

Discount Points. One point equals one percent of the loan amount. Paying points has the effect of giving the lender a higher yield. Two points on a $100,000 mortgage would cost $2,000 ($100,000 x 0.02).

Down Payment. The portion of the purchase price paid by a buyer to a seller from sources of funds outside of those provided by a lender.

Due Diligence. The act of carefully reviewing, checking and verifying all of the facts and issues before proceeding. In lending it is, among other things, verification of employment, income and savings; review of the appraisal; credit report; and status of the title.

Due-on-Sale. A typical clause of a mortgage requiring that the outstanding balance be paid in full on the sale of the property. In recent years the language of this clause has been broadened in many mortgages to include as the triggering event not only the actual sale of a property but the transfer of any interest in the property.

Equity. The value of the unencumbered interest in real estate as determined by subtracting the total of the unpaid mortgage balances plus the sum of any current liens against the property from the property's fair market value.

Escrow Account. An account from which funds can be disbursed only for specified reasons; i.e. the money is held in trust for a specific use. In lending, these accounts are most often used to hold and disburse real estate taxes and hazard insurance premiums which have been paid in advance (usually on a monthly basis) by the borrower.

Fair Market Value. The price that an interested but not desperate buyer would be willing to pay and an interested but not desperate seller would be willing to accept on the open market assuming a reasonable period of time for an agreement to arise.

Fannie Mae (FNMA). Federal National Mortgage Association, a federally chartered corporation that purchases mortgages and packages them to sell as securities.

Fee Agreement. An agreement between a borrower and a broker which normally specifies the relationship between them and the amount of compensation to the broker.

Fiduciary Responsibility. An obligation to act in the best interest of another party. This type of obligation typically exists when one person places special trust and confidence in another person and that responsibility is accepted.

First Mortgage. That mortgage which is recorded at the earliest time. The time of recording is the sole criteria. Size of loan and type of mortgage are immaterial. When the first mortgage is paid off and released, the second mortgage (if any existed) becomes the first mortgage.

Fixed Rate Mortgage. A mortgage with an interest rate that remains the same through the life of the loan.

Foreclosure. The process by which the mortgagor's (borrower's) rights to a property are terminated. While the general process is similar from state to state, the actual procedures tend to vary greatly.

Freddie Mac (FHMLC). Federal Home Loan Mortgage Corporation, a federally chartered corporation that purchases mortgages and packages them to sell as securities.

Gross Monthly Income. Income before deductions for taxes, social security, saving plans, court ordered child support, etc.

Hard Money Loan. A loan that is underwritten with the condition and value of the property as the primary criteria for approval. Secondary issues may include the credit of the borrower, the ability of the borrower to repay the loan and/or the ability of the borrower to manage the property or successfully complete a rehab and sell the property. Owner occupancy, debt ratios and other issues are seldom a factor. Appraisals rather than purchase prices are used to determine value. Cash out purchases are often allowed and are another key benefit. These loans are usually approved within days and are often funded in two weeks or under with times as short as two or three days not uncommon. The cost for the benefits of speed of funding, lax underwriting and other advantages is typically a moderately high interest rate (usually low to mid teens) and high points (usually 5 to 10). (See definition of "underwriting" below.)

Hazard Insurance. Insurance to provide compensation if the improvements are damaged or destroyed. It is almost always a requirement of loans.

Home Equity Loan. In the most literal sense, this expression applies to virtually all loans (first mortgages and second mortgages, fixed and adjustable interest rates, credit lines and fully amortizing loans, etc.) placed on an owner occupied property when the loan-to-value after the Home Equity Loan closes is no higher than 100%. That is, it is a loan secured by the available equity of an owner occupied residential property.

However, in many (if not all) areas of the country, intense marketing (from banks in particular) has caused this expression to take on one particular meaning, that of a credit line (usually a second mortgage with an adjustable interest rate) secured by a residence. They are sometimes called a Home Equity Line of Credit. Since many of these loans are promoted with features such as easier application forms, fast approvals, drive-by appraisals and low or no closing costs they don't register within the minds of many consumers in the same way as the typical first mortgage used to purchase a home. It is not uncommon, even after just signing the documents at the closing, for some consumers to think there is not even a mortgage involved! They can be used as low cost tools for investors.

Initial Note Rate. The rate of interest that takes effect at the closing of a loan and which determines the monthly payment(s) for the early portion of the loan. The period of time during which this rate applies is often short and the rate may be lower than

Index. The published cost of money that serves as the minimum basis for determining the interest rate for an adjustable rate mortgage. Among the commonly used indices are the Prime Rate (Prime), the London Interbank Offering Rate (LIBOR), the Cost of Funds (COF) and the 1 year Treasury Bill (1 year T). The particular index is generally, though not always, selected based on how often an interest rate is supposed to adjust. Loans which allow monthly interest rate adjustments commonly use the Prime Rate. Loans that adjust semi-annually may use LIBOR. The 1 year Treasury and the Cost of Funds are often used for loans which adjust on an annual basis. There are other Treasury instruments which are used for 3 and 5 year adjustment periods.

The interest rate of the loan is determined by adding a margin to the index. The size of the margin is typically a function of the index used and the credit worthiness of the borrower. Typical margins on a Prime Rate based loan would be 0.0 to 5.0 so that if the Prime Rate were 8.25% and the margin were 2.0 (typical for an "average" borrower), the interest rate would be 10.25% (8.25 + 2.0).

Interest Rate. The percentage of the loan amount charged for borrowing money; i.e., the cost of the money expressed as a percentage.

Jumbo Loan. A loan larger than the maximum allowed by conforming loans. The threshold amount has traditionally been adjusted more or less on an annual basis and has been in the low $200,000's. Banks and mortgage brokers can quote the current threshold. They are typically available at interest rates slightly higher than those of conforming loans and typically require the same underwriting standards as conforming loans. (see definition of "conforming loan" above)

Lien. A claim on a property of another as security for money owed. Examples of types of liens would include judgments, mechanic's liens, mortgages and unpaid taxes.

Lifetime Cap. The highest amount over the initial interest rate that an adjustable mortgage can be raised. Lifetime caps are typically in the range of 5.0% - 7.0%. If the initial interest rate is 5.25% and the lifetime cap is 6.0%, the highest interest rate a borrower could pay during the course of the loan would be 11.25% (5.25% + 6.0%).

Loan-to-Value (LTV). The ratio of the size of the loan to the value of the property. If the loan is $80,000 and the value of the property is $100,000 the LTV is 80% ($80,000 / $100,000).

Loan Package. The organized group of documents that contains all of the information required to obtain an underwriting decision of loan approval or loan denial. Depending on the type of loan and the particular lender, a package may contain some or all of the following as well as other documents: loan application, statement of use of funds, statement of net worth, P & L statements, tax returns, pay stubs, statements from various types of banking and investment accounts, property appraisal, letters of explanation, credit report, verification of employment, verification of housing payments, purchase agreement, etc. (See definition of "underwriting" below.)

Margin. A constant (fixed) amount over an index that determines a lender's yield on an adjustable rate loan. The interest rate of an adjustable rate loan is determined by adding a margin to an index. The size of the margin is typically a function of the index used and the credit worthiness of the borrower. Typical margins on a Prime Rate based loan would be 0.0 to 5.0 so that if the Prime Rate were 8.25% and the margin were 2.0 (typical for an "average" borrower), the interest rate would be 10.25% (8.25 + 2.0). (See definition of "index" above.)

Mortgage. A lien against real property given by a borrower to a lender as security for money borrowed.

Mortgagee. The entity to whom the mortgage is given; i.e., the lender.

Mortgage Insurance Premium (MIP). The payment made by a borrower of FHA insured mortgages to provide a reserve that protects lenders against losses from very high loan-to-value loans.

Mortgage Loan. A loan which is secured by a mortgage lien filed against real property.

Mortgage (Open-End). A mortgage that allows additional money to be borrowed (up to the original loan amount) without refinancing the loan or paying additional financing charges .

Mortgagor. The entity who gives the mortgage; i.e., the borrower.

Net Operating Income (NOI). From income producing property, the gross income minus the total of all expenses except for debt service. Cash flow is defined as NOI minus the total of all debt service payments.

No Income Verification Loan (NIV). A type of loan generally limited to the self-employed that is underwritten based on the borrower's written representation of their annual income as stated on the loan application. No tax returns, operating statements or other verification of the income is required. Debt ratios are computed based on the stated income. The primary intent of these programs is to allow owners of small businesses to use their actual cash flows rather than the net incomes normally reported in tax filings. Higher interest rates on these products compensate lenders for their higher risks. (See definition of "debt ratio" above.)

Non-conforming Loan. A loan not meeting the underwriting requirements of Fannie Mae and Freddie Mac. I.e., the vast majority of loans.

Note. A written promise to repay a certain sum of money on specified terms.

Note Broker. An individual who acts as an intermediary between a holder of an existing note and a prospective purchaser of the note.

Originator. An individual who works with a borrower to start a loan. Usually an employee of a financial institution, an employee of a broker or an independent contractor affiliated with several brokers, the originator determines the type of loan a borrower probably qualifies for, helps complete an accurate application, gathers documents necessary to get an approval and acts as an intermediary between the borrower and the underwriter.

Origination Fee. A fee paid to either a broker or a lender for originating a loan. It may be the only compensation for their work in arranging and/or processing the loan or it may be only a portion of the compensation. Not every loan has an origination fee.

PITI. The shorthand way of stating the most usual elements of a residential mortgage payment which may consist not only of the Principal and Interest (PI) but the property taxes (T) and hazard insurance (I) as well. In the case where all four elements are part of the payment, the lender escrows the T and I and pays them on behalf of the borrower when they come due. Some loans are written such that the payment to the lender consists only of the P and I in which case the borrower pays the taxes and insurance directly.

Portfolio Loan. A non- conforming loan that is held by the original lender rather than being sold on the secondary market.

Prepayment Penalty. A fee charged for paying off a loan within a relatively short period of time after the loan has closed. This provision is currently found only in non-conforming products. The time period during which it applies is usually one to three years and the amount of the penalty is usually 1.0% - 3.0% of the original loan amount though other, more complicated formulas are sometimes used. These provisions are sometimes regulated by state law. If a $50,000, 15 year loan were paid off in six months on a loan that had a 1.0% prepayment penalty, the penalty would be $500 ($50,000 x 0.01).

Principal. The amount being borrowed.

Private Mortgage Insurance (PMI). The insurance premium paid by a borrower to protect lenders against losses from loans with loan-to-value ratios higher than 80%. (See definition of "loan-to-value" above.)

Purchase Money Mortgage. A mortgage which secures a note written on a loan used in the purchase of real estate.

Purchase Subject to Mortgage. A purchase in which a buyer agrees to make the monthly mortgage payments on an existing mortgage and in which the original borrower remains liable if the purchaser fails to make the payments as agreed at the time the loan was originally closed.

Rescission Period. A federally mandated period of three business days (beginning on the day after a loan closes) during which the borrower may cancel the new loan. This waiting period only applies to loans which are to be secured by a mortgage on a personal residence for which the borrower is in title at the time of loan origination. This right to cancel does not apply to loans used for the purchase of property. Funds from these loans can only be disbursed after the rescission period.

Refinance. The process of a borrower paying off one loan with the proceeds from another.

Seasoned Loan. A loan which has been in force for a period of time and, therefore, has the borrower's payment history associated with it. For most purposes, loans are deemed to be "seasoned" after either six months or one year.

Second Mortgage. That mortgage which is recorded after one other mortgage has already been recorded (and has not yet been released). When the first mortgage is paid off and released, the second mortgage becomes the first mortgage.

Statement of Net Worth. A document which contains in an organized fashion all of the financial assets and liabilities of an individual or other entity.

Subordination. An agreement to let an inferior lien (one filed later in time) take precedence (be considered as if it were in a superior position). It is not an uncommon for a lender considering a loan request for a large mortgage (particularly one that will refinance a first mortgage) to require that a second mortgage already in place remain, in effect, in second position through the use of a subordination agreement.

Teaser Rate. An interest rate lower than true stated interest rate of the loan which is in effect for the first few months of a loan. It is used as an inducement to attract borrowers.

Term. The length of time for which money can be borrowed.

Underwriting. The act of applying formal guidelines that provide qualitative and quantitative standards for determining whether or not a loan should be approved.

Yield. Return on investment (the rate at which an investment pays interest and/or dividends).