“Well, the reason your mortgage rate increased is that the appraisal came in low, which raised the LTV so we suspended the file. Then we had to redraw and blew the lock.”
Home loan jargon can be annoying and confusing, and you’d probably not want to do business with a loan officer or broker who uses it. However, some mortgage industry terms can’t be avoided, so you should probably understand them before you shop for financing.
Mortgage Alphabet Soup: Eat it Up!
Many mortgage expressions are abbreviations, which can make them even more confusing. Here are the most common terms you’ll hear in a mortgage lender’s office.
No; it’s not a new kind of plasma screen. LTV means loan-to-value, which is the percentage of the home’s appraised value or sales price (whichever is lower) that’s being financed. For example, if you buy a home for $100,000, putting $20,000 down and borrowing $80,000, your LTV is 80 percent. $80,000 / $100,000 = .8. If you buy a home for $320,000 and put $20,000 down, your LTV is $300,000 / $320,000, which is 93.75 percent. Loans with lower LTVs are less risky for lenders and usually come with lower mortgage rates.
APR stands for annual percentage rate. Whenever a mortgage lender advertises or quotes a mortgage rate, it also has to disclose the loan’s APR. The mortgage rate (also called the stated rate) is used to calculate the monthly payments, but it tells you nothing about the cost of the financing. For example, a $100,000 mortgage with a 4.125 percent rate might cost $10,000 or it might cost $2,000 or it might cost zero. You can’t tell from the rate. But here’s how the APRs shake out:
Loan Amount: $100,000
Interest Rate: 4.125%
Cost: $10,000 APR: 11.22%
Cost: $2,000 APR: 5.72%
Cost: $0 APR: 4.125%
APR helps you compare mortgages with different rates and costs. If you have two mortgage quotes -- one with a 3.875 percent rate costing two points and the other with a 4.125 percent rate costing .5 points, which is the better deal? Knowing that the first loan's APR is 4.04 percent and the second loan's APR is 4.17 percent might help you make your decision. You might say that APR helps you spot BS.
ARM is short for adjustable rate mortgage. Unlike fixed-rate mortgages (FRMs), ARMs have interest rates that can change over time. Fixed-rate home loans can be risky for lenders. If you have a mortgage with a low fixed rate and then interest rates rise, the lender is stuck with a low rate of return on its investment. Adjustable rate mortgages have rates that can change with economic conditions. This reduces the risk to lenders, so they offer lower rates to borrowers. For example, when a 30-year fixed home loan has an interest rate of four percent, a 5/1 ARM (the rate is fixed for 5 years and then changes every year after that) might come with an interest rate of three percent.
When ARMs adjust, they can go up or down. ARMs have several components that determine how they behave over time:
- Start rate (also called the introductory rate or teaser rate). This is the interest rate when you close on your home loan. For a 5/1 ARM, that start rate is good for five years. With a 1-year ARM, the start rate is in effect for one year.
- Index. The index is a published financial measurement. Common indexes include the LIBOR and T-Bill.
- Margin. This is a percentage that gets added to the margin when the rate adjusts. It represents revenue to the lender.
- Caps and floors. These limit how much a rate can be adjusted and how high or low the rate can go over the life of the loan.
When your mortgage rate adjusts, the margin is added to the index to come up with what is called the fully-indexed rate.
The GFE is your Good Faith Estimate. This disclosure shows the cost of your mortgage. Lenders are required to provide a GFE within three business days when you apply for a home loan, but many will give you a GFE when you get a mortgage quote. By law, your actual costs when you close on your home loan must match what was disclosed within certain limits. Some costs must match exactly, while others can vary slightly. Your GFE has a lot of important information.
- Important dates – this is when the rate quote or lock expires, and how long the fees disclosed will be available.
- Summary -- the most important elements of the mortgage – the loan amount, interest rate, and term. It tells you if the loan has rate resets, negative amortization, a balloon payment or prepayment penalty.
- Escrow account information – discloses escrow account requirements to pay your property taxes and homeowners insurance premiums.
- Summary of your settlement charges condenses all fees into two bottom-line numbers, total lender charges and total other charges. It doesn’t matter if lender fees are called “points,” “origination fees,” “processing and underwriting charges,” or “milk shakes.” All that matters is the Total Estimated Settlement Charges.
- Adjusted Origination Charges. This shows your origination fee. If the fee includes a credit toward other settlement costs, you’ll see that here. If you’re paying discount points, which are extra fees used to lower your interest rate, you’ll see them here too.
- Your Charges for All Other Settlement Services. They are listed in several boxes.
TIL means Truth In Lending. Some people think that the TIL disclosure was named for the Truth In Lending Act (TILA) of 1968 (The form was updated with the passage of the Mortgage Disclosure Improvement Act of 2008.) However, others claim the form gets its name because lenders are not allowed to charge you any fees (other than for a credit report) ‘TIL you receive the disclosure! In addition, a new form must be provided if the APR changes, and your loan can’t close for at least seven days after you've received your initial TIL or three days following receipt of an updated or revised TIL.
The TIL discloses a few biggies -- first, your APR, which expresses the cost of your mortgage (interest and fees) as an interest rate for easier comparison between programs with different rates and fees. Second, it gives you the cost of credit over the life of the loan, and finally, it tells you what your payments are and when they are due.
DTI means your debt-to-income ratio. When mortgage underwriters evaluate your application, they calculate your DTI in two forms. The first form is called your top-end or front-end ratio, and it means your housing expenses divided by your gross (before tax) income. So, if your gross income is $5,000 per month, and your mortgage payment plus homeowners insurance and property taxes is $1,000 per month, your front-end ratio is $1,000 / $5,000, which is .2 (20 percent).
The other form of DTI is the bottom end or back-end ratio. It’s considered the more important number, and it means taking the total of all monthly obligations (for example, your housing expense, car payment, student loan payment, and credit cards – but not utilities or other living expenses) divided by your gross income. So if you have $800 in monthly payments plus the $1,000 in housing expense, your back-end ratio equals $1,800 / $5,000, which is .36 (36 percent).
If you ever hear a loan officer or broker say that you have an ugly back end, they are talking about this ratio – not the fit of your jeans!
If you understand these terms before looking for a home loan, you’ll find dealing with mortgage lenders and closing your loan a lot easier. If your loan officer ever says something you don't understand, make him or her explain it, and if anyone ever says something like the first sentence in this article, you're being subjected to Bank Speak and you should find another lender fast!