Some general mortgage loan and financing terms are explained
Common terms used to describe a mortgage include “lender,” “debtor,” and “mortgage broker.” It may be clear what these terms mean, but there are other mortgage-related terms that a homeowner may not be completely familiar with. Let’s look at some of them here:
creditor
The lender is the financial institution, usually a bank, that provides the money in the form of a loan for the amount of the mortgage. The lender is sometimes called the mortgagee or lender.
debtor
The debtor is the person or party who owes the mortgage or loan. They can be named as a 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, etc. If this is the case, both individuals become debtors on this loan, not just the owners of the property.
In other words, be careful about having your name put on the deed or title to any house, as it also makes you legally responsible for the mortgage or loan associated with that house.
Mortgage broker, financial advisor
Mortgage loans are not always easy to obtain, but due to the demand for housing in most countries, there are many financial institutions that offer them. Banks, credit unions, savings and loans, and other types of institutions can offer mortgages. A mortgage broker can be used by the prospective borrower to find the best mortgage at the lowest interest rate for them; the mortgage broker also acts as the lender’s agent to find people willing to take on these mortgages, handle the paperwork, etc.
There are usually other parties involved in closing or obtaining a mortgage, from attorneys to financial advisors. As a home mortgage is usually the largest debt any person will have in their lifetime, they often seek whatever legal and financial advice is available to them in order to make the right decision. A financial advisor is someone who can get to know your own specific needs, income, long-term goals, etc., and then give you the best advice on what your loan needs might be.
Foreclosure
When the debtor cannot or does not meet the financial obligations of the mortgage, the property can be foreclosed, which means that the lender seizes the property to recover the remaining cost of the loan.
Typically, a home that is in foreclosure will be sold at auction and that sale price will be applied to the outstanding amount of the mortgage; the debtor may still be liable for the remaining amount if the property is sold for less than the outstanding mortgage balance.
For example, suppose a person still owes $50,000 on their mortgage and their home is in foreclosure. At auction, the home sold for just $45,000. The debtor is still responsible for that remaining $5,000 difference.
Most banks and financial institutions will try to avoid foreclosure on 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 at any price, but there are additional costs and risks when the home is vacated by the previous owners. This includes vandalism, squatters (people who enter vacant land or vacant homes and remain there until they are forcibly removed), fines from cities for untidy yards, etc.
Annual Percentage Rate (APR)
APR should not be confused with mortgage interest rate.
The APR is the interest rate on the loan plus the added costs of obtaining the loan, such as points, down payment fees and mortgage insurance premiums (if applicable).
If there were no costs associated with obtaining a loan other than the interest rate, then the APR would be equal to the interest rate.
Breakeven point
The break-even point is the length of time it takes to recoup the costs incurred to refinance a mortgage. It is calculated by dividing the amount of refinancing closing costs by the difference between the old and the new monthly installment.
For example, if refinancing your mortgage costs you $5,000 in fees, penalties, etc., but you save $300 per month on your new mortgage payments, the break-even point is after 17 months (17 months x $300 per month = $5100).
ARM
This refers to an adjustable rate mortgage; a mortgage that allows the lender to periodically adjust its interest rate.
Fixed rate mortgage
A mortgage where the interest rate does not change during the term of the loan.
Cap
ARMs have variable interest rates, but these fluctuations are usually limited by law to a certain amount.
These limits can apply to how much the loan can be adjusted over a six-month period, an annual period, and over the life of the loan, and are called “caps.”
Index
A number used to calculate the interest rate for an ARM. An index is usually a published number or percentage, such as the average interest rate or US Treasury yield. A margin is added to the index to determine the interest rate that will be charged on the ARM.
Because the index can vary by ARM, many people considering refinancing do well to know the standard interest rate set by the federal government, as it is typically used by lending institutions to calculate this index.
Base rate
The interest that banks charge their preferred customers. Changes in the prime rate affect changes in other interest rates, including mortgage rates.
Equity
Homeowner’s financial interest or property value. Equity is the difference between the property’s fair market value and the amount still owed on its mortgage and other liens, if that value is higher.
In other words, if the home’s fair market value 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 against a specific property, which are made against the “equity” of the property after it is purchased.
Using the above illustration of a home that has $50,000 in equity, a homeowner can borrow up to that amount by using the home as collateral for that loan. The lending institution knows that if the homeowner defaults on the loan, they can foreclose on the property and sell it for at least that much, recouping the loan amount.
Amortization
The gradual repayment of a mortgage loan, usually through monthly payments of principal and interest.
An amortization table shows the payment amount broken down into interest, principal and unpaid balance over the life of the loan. These tables are useful because when a mortgage payment is made, the same amount is not applied to the principal and interest month after month, even when the payment amount is the same. This is often a difficult concept to understand for those not in the real estate or banking business, so an amortization table that describes how each payment is applied to the debt over the life of the loan can be very helpful.
Payout refinancing
When a borrower refinances their mortgage to an amount higher than the current loan balance with the intention of withdrawing money for personal use, it is called a “cash-out refinance.” In other words, the mortgage is not only for the home itself, but an additional amount of money is also financed.
Appraised value
An opinion of the property’s fair market value based on the property appraiser’s knowledge, experience and analysis. 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 reasons.
Amortization
Decline in property value; the opposite of appreciation.
Appreciation and depreciation are important concepts to remember; As we just mentioned, the appraised value of the home is a determining factor in the home mortgage. When refinancing, it’s important to understand that the value of your home may have appreciated or depreciated since taking out the original or first mortgage.
I’m locking up
An agreement in which the lender guarantees a certain interest rate for a certain period of time at a certain price.
Lock-in period
The period of time during which the lender has guaranteed an interest rate to the borrower.
This is a different concept than a fixed rate mortgage, as the lock-in period for a mortgage may be temporary rather than for the entire term of the loan.
As we said earlier, many of these terms may already be familiar to you, but it doesn’t hurt to review them and see how they all relate to your mortgage and 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 refinancing process in more detail.
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