Loan Lingo

APR? FRM? Balloon loan? It’s easy to get overwhelmed by jargon while shopping for a loan. Credit.com explains the most commonly used terms and how they apply to you and your loan application:

Adjustable Rate Mortgage (ARM): A home loan where the interest rate changes periodically based upon a standard financial index. ARMs offer lower initial interest rates with the risk of rates increasing in the future. In comparison, a fixed rate mortgage (FRM) offers a higher rate that will not change for the length of the loan. ARMs often have caps on how much the interest rate can rise or fall. You can shop and compare mortgage options securely online.

Alternative Mortgage: Any home loan that is not a standard fixed rate mortgage. This includes ARMs, reverse mortgages, and jumbo mortgages.

Application Fee: The amount a lender charges to process loan application documents. Quality lenders do not charge these fees (though they may charge many others).

Appraisal Fee: The amount charged to deliver a professional opinion about how much a property is worth. For a standard home or condominium, this fee is usually around $200-500.

Back-End Ratio or Back Ratio: The sum of your monthly mortgage payment and all other monthly debts (credit cards, car payments, student loans, etc.) divided by your monthly pre-tax income. In the past, lenders wouldn’t give loans to people whose ratio was higher than 36%, but they often do now. (See Debt-to-Income Ratio)

Balloon Payment: A loan where the payments don’t pay off the principal in full by the end of the term. When the loan term expires (usually after 5-7 years), the borrower must either pay a balloon payment for the remaining amount or refinance. Balloon loans sometimes include convertible options that allow the remaining amount to automatically be transferred into a long-term mortgage. (See Convertible ARM.)

Closing Costs: The amounts charged to a consumer when they are transferring ownership or borrowing against a property. Closing costs include lender, title, and escrow fees and usually range from 3-6% of the purchase price.

Combined Loan-to-Value Ratio: The total amount you are borrowing in mortgage debts divided by the home’s fair market value. Someone with a $50,000 first mortgage and a $20,000 equity line secured against a $100,000 house would have a CLTV ratio of 70%.

Commitment Fee: A fee paid by a borrower to a lender in exchange for a promise to lend money on certain terms for a specified period. Usually charged in order to extend a loan approval offer for longer than the 30-60 day standard period. Quality lenders don’t usually charge these fees.

Conforming Loan: A mortgage that meets the requirements for purchase by Fannie Mae and Freddie Mac. Requirements include size of the loan, type, and age. Current loan size limits for single-family homes range between $200,000 and $400,000. Loans that exceed the conforming size are considered jumbo mortgages and usually have higher interest rates.

Co-Signer: An additional person who signs a loan document and takes equal responsibility for the debt. Borrowers may want to use a co-signer if their credit or financial situation is not good enough to qualify for a loan on their own. A co-signer is legally responsible for the loan and the shared account will appear on his or her credit report. Having a co-signer is only helpful if the co-signer’s credit or financial standing is better than the primary lender.

Debt-to-Income Ratio: The percentage of your monthly pre-tax income that is used to pay off debts such as auto loans, student loans, and credit card balances. Lenders look at two ratios: The front-end ratio is the percentage of monthly pre-tax earnings that are spent on house payments. In the back-end ratio, the borrower’s other debts are factored in along with the house payments.

First Mortgage: The primary loan on a real estate property. This loan has priority over all other “secondary” loans.

Fixed-Rate Option: A home equity line of credit financing option that allows borrowers to specify the payments and interest on a portion of their balance. This can be done a few times during the life of the loan, usually for an additional fee.

Fixed Rate Mortgage (FRM): A mortgage with an interest rate that remains constant for the entire duration of the loan. FRMs have longer terms (15-30 years) and higher interest rates than adjustable rate mortgages but are not subject to variable interest rates. You can shop and compare mortgage options securely online.

High-LTV Equity Loan: A specific kind of home loan that causes your loan-to-value ratio to be 125% or more. When the total principal of a loan leaves the borrower with debt that exceeds the fair market value of the home, the interest paid on the portion of the loan above that value may not be tax deductible.

Income Verification: Loan applications may require fully documented proof of an applicant’s income. Loans of this type usually offer lower interest rates than no-income or “no-doc” verification loans.

Interest Rate Cap: A limit on how much a borrower’s percentage rate can increase or decrease at rate adjustment periods and over the life of the loan. Interest rate caps are used for ARM loans where the rates can vary at certain points.

Interest-Only Loan: A type of loan where the repayment only covers the interest that accumulates on the loan balance and not the actual price of the property. The principal does not decrease with the payments. Interest-only loans usually have a term of 1-5 years.

Jumbo Mortgage: A loan that exceeds the limits set by Fannie Mae and Freddie Mac (usually when the loan amount is more than $200,000-400,000). Also known as a non-conventional or non-conforming loan, these mortgages usually have higher interest rates than standard loans.

Loan Origination Fee: A fee charged by a lender for underwriting a loan. The fee often is expressed in “points;” one point is 1% of the loan amount.

Loan Processing Fee: A fee charged by a lender for accepting a loan application and gathering the supporting paperwork, usually about $300.

Loan-to-Value Ratio (LTV): The percentage of a home’s price that is financed with a loan. On a house worth $100,000, if the buyer makes a $20,000 down payment and borrows $80,000, the loan-to-value ratio is 80%. When refinancing a mortgage, the LTV ratio is calculated using the appraised value of the home, not the sale price. You will usually get the best deal if your LTV ratio is below 80%.

Low-Documentation Loan: A mortgage that requires less income and/or assets verification than a conventional loan. Low-documentation loans are designed for entrepreneurs or self-employed borrowers - or for borrowers who cannot or choose not to reveal information about their incomes.

Low-Down Mortgages: Secured loans that require a small down payment, usually less than 10%. Often, low-down mortgages are offered to special kinds of borrowers such as first-time buyers, police officers, veterans, etc. These kinds of loans sometimes require that the borrower purchase mortgage insurance.

Mortgage Banker: A person or company that originates home loans, sells them to investors (such as Fannie Mae), and processes monthly payments.

Mortgage Broker: A person or company that matches lenders with borrowers who meet their criteria. A mortgage broker does not make the loan directly like a mortgage banker, but receives payment for their services. (See Broker Premium.)

Mortgage Interest Expense: A tax term for the interest paid on a loan that is fully deductible, up to certain limits, when you itemize income taxes.

No-Documentation Loan: A mortgage in which the applicant provides only minimum information - name, address, and Social Security number. The underwriter decides on the loan based only upon the applicant’s credit history, the appraised value of the house, and the size of down payment. This type of loan usually has higher interest rates than a standard loan.

PITI: Acronym for the four elements of a mortgage payment: principal, interest, taxes, and insurance.

Point: A unit for measuring fees related to a loan; a point equals 1% of a mortgage loan. Some lenders charge “origination points” to cover the expense of making a loan. Some borrowers pay “discount points” to reduce the loan’s interest rate. Shop and compare mortgage offers online.

Pre-Approval Letter: A document from a lender or broker that estimates how much a potential homebuyer could borrow based upon current interest rates and a preliminary look at credit history. The letter is a not a binding agreement with a lender. Having a pre-approval letter can make it easier to shop for home and negotiate with sellers. It is better to have a pre-approval letter than an informal pre-qualification letter.

Prepayment Penalty: A fee that a lender charges a borrower who pays off his or her loan before the end of its scheduled term. Prepayment penalties are not charged by most standard lenders. Subprime borrowers should review the terms of their loan offers carefully to see if this fee is included.

Pre-Qualification Letter: A non-binding evaluation of a prospective borrower’s finances to determine how much he or she can borrow and on what terms. A pre-qualification letter is a less formal version of a pre-approval letter.

Principal: The amount of money borrowed with a loan or the amount of money owed, excluding interest.

Private Mortgage Insurance (PMI): A form of insurance that protects the lender by paying the costs of foreclosing on a house if the borrower stops paying the loan. Private mortgage insurance usually is required if the down payment is less than 20% of the sale price.

Qualifying Ratios: As calculated by lenders, the percentage of income that is spent on housing debt and combined household debt.

Second Mortgage: A loan using a home’s equity as collateral. A first mortgage must be repaid before a second mortgage in a sale.

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