Listening to mortgage loan officers talk about real estate financing is sometimes like overhearing a conversation in a foreign country. You catch the words but their meaning is unclear if not mysterious.
A lot of words and expressions used in mortgage finance are strange and unusual simply because most of us rarely have a need to employ such terms. So to help borrowers, here's a brief guide to common -- if sometimes strange -- terms used by mortgage lenders.
11th District Cost of Funds Index (COFI)
The COFI, according to the Federal Home Loan Bank of San Francisco, "is computed from the actual interest expenses reported for a given month" by its member savings institutions in Arizona, California, and Nevada. This index is used to calculate interest rates for some adjustable mortgage products.
Adjustable Rate Mortgage (ARM)
A form of financing in which the interest rate may go up or down during the life of the mortgage. Most ARMs have an introductory period with a low fixed interest rate, and once that period expires they begin adjusting at regular intervals according to the terms set by the lender. Most ARMs limit how much the interest rate can increase at each adjustment period and also how high the rate can go over the life of the loan.
The process by which a loan balance is paid off. Each payment covers the monthly interest due, and the amount left over is used to reduce the principal balance. Over time, the balance is lowered, less is needed to cover the interest due, and more of the payment is allocated toward reducing the principal. By the end of the loan term (360 months for a 30 year mortgage), the balance is completely retired.
Annual Percentage Rate (APR)
The cost of borrowing when the interest rate and fees to originate a loan are combined. The APR is a common benchmark used by borrowers to compare loans. The higher the loan fees, the higher the APR. For example, here are three $100,000 mortgages. They all have a 4.00 percent interest rate, but one costs nothing, one costs $2,000 and one has fees of $5,000. Here are their APRs:
- $0 costs, APR = 4.000 percent
- $2,000 costs, APR = 4.168 percent
- $5,000 costs, APR = 4.430 percent
Annual Percentage Offer Rate (APOR)
An index published by the federal government which lenders use to price qualified mortgages. If the interest rate does not exceed the APOR plus 1.5 percent, the lender is generally shielded from borrower claims that the loan is not a qualified mortgage.
Credit Reporting Agency
An organization which collects credit information for distribution in the form of a credit report. The three largest credit reporting agencies (also called credit bureaus) are Experian, Transunion and Equifax.
Department of Veterans Affairs (VA)
The federal agency that guarantees mortgages made to individuals with qualifying federal service, usually active-duty service members, veterans and sometimes their families.
Also known as Wall Street Reform, this is a major piece of federal legislation designed to limit risk in the mortgage marketplace for borrowers, lenders and mortgage investors. It requires lenders to show that the borrower has the ability to repay the loan, establishes standards for qualified mortgages or QMs, and creates several foreclosure defenses for borrowers.
Equal Credit Opportunity Act
Federal legislation which prohibits the denial of credit on the basis of race, color, religion, national origin, age, sex, marital status or the receipt of income from public assistance programs.
Federal Housing Administration (FHA)
A part of the Department of Housing and Urban Development (HUD), the FHA does not make loans. Instead, the FHA insures loans for qualified individuals who wish to purchase homes with less than 20 percent down.
Fair Isaac Corporation (FICO)
A pioneer in the development of credit scores. Credit scores are numerical values calculated from formulas and based on such factors as payment history, amounts owned, length of credit history, types of credit used and new credit. Today, a number of organizations offer competing credit score systems, but FICO is the most widely-used.
Good Faith Estimate (GFE)
A standardized form developed by the federal government which lenders must provide to mortgage applicants within three business days. Will be replaced as of August 1, 2015 by a "Loan Estimate" form.
Home Equity Line of Credit (HELOC)
A mortgage in the form of a line of credit. Think of it as a giant credit card secured by real estate. Because a HELOC is secured by real estate, the interest is generally tax deductible. Speak with a tax professional for specifics.
Also called a "closing statement," the HUD-1 discloses the costs of a real estate transaction and what amounts are paid to which recipients. The final financing costs are compared to those listed on the most recent Good Faith Estimate (GFE) to make sure they don't vary by more than the law allows. Will be replaced as of August 1, 2015 with a "Closing Disclosure" form.
Loan-to-Value Ratio (LTV)
A ratio which compares the fair market value of a property as determined by an appraisal or sale price, whichever is less, and the amount being borrowed against it. For example, if a $100,000 home is purchased with an $80,000 mortgage, the LTV is 80 percent.
London Interbank Offered Rate (Libor)
An index used to compute interest rates for many financial products, including many adjustable-rate mortgages (ARMs). Based on the cost of bank borrowing in London.
Principal and Interest (P and I)
This is a basic mortgage payment. Part of the monthly payment on a fully-amortizing mortgage is used to pay interest due, and what's left over pays down the principal balance of the loan. Many mortgage borrowers also pay extra to cover taxes and homeowners insurance -- those are called impounds and are not part of the P and I.
Principal, Interest, Taxes and Insurance (PITI)
PITI includes the basic mortgage payment (the principal and interest, or P and I) PLUS impounds -- amounts to cover 1/12th of the annual property tax and 1/12th of the cost of homeowners insurance.
Private Mortgage Insurance (PMI)
A form of insurance for borrowers who wish to buy a home with less than 20 percent down, or refinance with less than 20 percent home equity. If the borrower defaults on the home loan and the foreclosure sale doesn't bring enough to cover the loan balance, the mortgage insurer pays the difference to the lender. Private mortgage insurance is similar to the mortgage insurance required by FHA, but it's furnished by private companies instead of the government.
Truth in Lending (TIL)
The federal Truth-in-Lending Act or TILA establishes various lending disclosure standards which lenders must follow when offering a mortgage product. The TIL disclosure contains the loan's total financing costs and its annual percentage rate (APR).
Real Estate Settlement Procedures Act. This consumer-protection law requires lenders to disclose (upon request) all of the costs involved in settling a loan and prohibits kickbacks that may increase these costs.