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Financial Terms Glossary

Adjustable Rate Mortgages (ARM)

A mortgage having an interest rate that varies depending on the change in some outside standard such as prime rate, interest rate on United States Treasury securities, or the Inflation rate. The lender can increase or decrease the interest rate on the mortgage at specified intervals based on changing market conditions. The mortgage agreement specifies when the interest rate may change and any limits imposed.

Adjustment Date

The date that the interest rate changes on an adjustable rate mortgage.

Amortization

The gradual and systematic reduction of debt by equal periodic payments. Such payments generally must be sufficient to recompense current interest due during the repayment period and to repay the entire principal by the time the loan reaches maturity. An amortization schedule is a table that shows the amounts of principal and interest due at regular intervals, and the corresponding unpaid principal balance at the time each installment payment is made.

Annual Percentage Rate (APR)

The rate required by Truth in Lending laws. It is designed to show customers the total cost of credit, including the stated interest rate plus certain finance and service charges.

Applicable Federal Rates (AFR)

The statutory interest rate that must be charged for most loans and installment agreements to avoid imputation of income under the Internal Revenue Code. The Treasury Departments determine three applicable federal rates monthly based on the current market yields on outstanding obligations of the

federal government with similar maturities. The federal short-term rate is applicable to transactions having terms of three years or less the federal midterm rate is applicable to transaction having terms of three to nine years, and the federal long-term rate is used for transaction having terms in excess of nine years. See also Interest, Loan, Installment Credit.

Appraisal

A physical inspection by a licensed ap-praiser, which provides an estimated value of the property based on recent sales comparable data of properties that are in close proximity of the sub-ject property and have sold within a three (3) to six (6) period of the inspec-tion date. This assists the lender in evaluating the loan request to deter-mine the amount of money that can be loaned on the property.

Appraisal Fee

The charge for estimating the value of property offered as security.

Appraiser

A professional who conducts an analysis of the property, including examples of sales of similar properties in order to develop an estimate of the value of the property. The analysis is called an “appraisal.”

Appreciation

An increase in the market value of a home due to changing market condi-tions and/or home improvements.

Arbitration

A process where disputes are settled by referring them to a fair and neutral third party (arbitrator). The disputing parties agree in advance to agree with the decision of the arbitrator. There is a hearing where both parties have an opportunity to be heard, after which the arbitrator makes a decision.

Assignment of Mortgage

Financial institutions often buy and sell mortgage loans from each other. This is a legal document evidencing the trans-fer from one mortgagee to another.

Assumable Mortgage

A type of financing agreement in which an outstanding mortgage loan and its terms can be transferred from the cur-rent owner to the buyer, when a home is sold. The seller remains liable unless released by the lender from the obliga-tion. The buyer can avoid having to ob-tain their own mortgage loan.

Automated Clearing House (ACH)

A computer-based clearing and settlement operation, often operated by a Federal Reserve Bank, established for the exchange of electronic transactions among participating depository institutions. Such electronic transactions can be substituted for paper checks used to make recurring payments such as mortgages, or in direct deposit distribution of federal and corporate benefits payments including Social Security payments. The U.S. Treasury uses the ACH extensively to pay certain obligations of the government.

Balance Inquiry

A basic function usually provided by home banking programs by which consumers can use a phone, personal computer or other electronic device to determine their balance of funds in a bank account.

Bankruptcy

State of insolvency or an organization--in other words, an inability to pay debts. There are two kinds of legal bankruptcy under the U.S. law: involuntary, when one or more creditors petition to have a debtor judged insolvent by a court; and voluntary, when the debtor brings the petition. In both cases, the objective is an orderly and equitable settlement of obligation.

Before-tax Income

Income before taxes are deducted. Also known as “gross income.”

Bi-Weekly Mortgage Payment

A loan in which the mortgage loan servicing institution collects half of your contractual monthly mortgage payments every two weeks. This results in 26 payments over the course of a year that applies one extra monthly payment per year to assist in paying off the loan sooner and saving money on long-term interest charges.

Borrower

Any legal entity that obtains funds from another for a period of time. In the case of an extension of credit, the borrower usually signs a note as evidence of the indebtedness.

Bridge Loan

A short-term loan secured by the borrower’s current home (which is usually for sale) that allows the proceeds to be used for building or closing on a new house before the current home is sold. Also known as a “swing loan.”

Buy-Downs

An amount a borrower pays in advance to lower the interest rate. Also called “discount points.”

Capacity

An applicant/borrower’s ability to earn enough income to make mortgage payments on time and still pay all other living expenses. This is also known as “ability to pay”.

Certificate of Deposit (CD)

A form of time deposit at a bank or savings institution; a time deposit cannot be withdrawn before a specified maturity date without being subject to an interest penalty for early withdrawal. Small-denomination CDs are often purchased by individuals. Large CDs of $100,000 or more are often in negotiable form, meaning they can be sold or transferred among holders before maturity.

Certificate of Eligibility

A document issued by the U.S. Department of Veterans Affairs (VA) certifying a veteran’s eligibility for a VA-guaranteed mortgage loan. This pro-vides an assurance to a private lender that if the borrower is unable to make the loan payments, the lender may be able to go the VA to cover its losses.

Certified Check

A check for which a bank guarantees payment. When the check is certified, it legally becomes an obligation of the banks, and the funds to cover it are immediately from the depositor's account.

Chapter 7

A provision of bankruptcy laws wherein a company is required to liquidate its assets to pay of its creditors.

Chapter 11

A provision of bankruptcy laws allowing a bankrupt company to remain in business while its owners attempt to pay its debts.

Chapter 13

Adjustments of debts of an individual with regular income under the Federal Bankruptcy Code. Chapter 13 enables a debtor who is an individual to develop and perform a plan for the prepayment of creditors over an extended period. The plan might provide for full or partial repayment. Chapter 13 allows the debtor to retain his or her property, unless he or she agrees otherwise in the plan.

Check Clearing

The movement of checks from the banks or other depository institutions where they are deposited back to those on which they are written, and funds movement in the opposite direction. This process results in credits to accounts at the institutions of deposit and corresponding debits to the accounts at the paying institutions. The Federal Reserve participates in check clearing through its nationwide facilities, though many checks are cleared by private sector arrangements.

Closing

The final step in the transfer of property ownership, which usually occurs at a formal meeting between the buyer, seller, settlement agent and possibly real estate agents, where the buyer signs the mortgage and mortgage note, the seller receives payment for the property, the buyer or seller or both pay closing costs and the title is transferred from the seller to the buyer. This is also called “settlement.” Some closing costs cannot increase at all, others can increase by up to 10 percent and others can increase by any amount.

Collateral

An asset such as an automobile or a piece of property that a person uses to take out a loan, promising to give the asset to the lender if loan payments cannot be met. Collateral also refers to the collection of receivables, such as mortgages, which are used to back the interest and/or principal security.

Compound Interest

Interest that is calculated on the original principal plus all interest accrued to that point in time. Since interest is paid on interest as well as the amount borrowed, the effective interest rate is greater than the nominal interest rate. The compound interest rate method is often used by banks and savings institutions in determining interest they pay on savings deposits "loaned" to the institutions by the depositors.

Cosigner

A term referring to a person, other than the principal borrower, who signs for a loan. The cosigner(s) assumes equal liability for the loan.

Credit History

A record of how a person has borrowed and repaid debt.

Credit Rating

An estimate of the amount of credit that can be extended to an individual or business without undue risk. (See also credit score)

Credit Report

A loan and bill payment history, kept by a credit bureau and used by financial institutions and other potential creditors to determine the likelihood that a future debt will be repaid.

Credit Score

Helps to predict how likely an applicant/borrower is to pay back a loan on time. Information provided to the credit reporting services help to derive the score. Lenders use the credit score to determine whether to extend a loan and it is also used to determine the interest rate you will receive on the loan.

Creditor

A person, financial institution or other business that lends money.

Creditworthiness

A creditor's measure of a consumer's past and future ability and willingness to repay debts.

Debit Card

A card that resembles a credit card but which debits a transaction account (checking account) with the transfers occurring contemporaneously with the customer's purchases. A debit card may be machine readable, allowing for the activation of an automated teller machine or other automated payments equipment.

Debt-to-Income Ratio

The percentage of all gross monthly income that goes toward paying for your monthly debts. Lenders use this data as a way to measure your ability to manage the debt payments you make every month to repay the money borrowed.

Debt Service

Periodic payment of the principal and interest on a loan.

Default

Failure to meet the terms of a credit agreement.

Delinquency

The failure to make timely payments under a loan or other credit agreement.

Equity

Ownership interest in an asset after liabilities are deducted.

Escrow

At closing, the borrower generally is required to set aside a percentage of the yearly taxes to be held by the lender. On a monthly basis, the lender collects additional money to be used to pay the taxes (and sometimes Private Mortgage Insurance, or PMI) on the home. The lender is responsible for paying the tax bills on a regular basis.

Fair Credit Reporting Act (FCRA)

A consumer protection law that imposes obligations on (1) credit bureaus (and similar agencies) that maintain consumer credit histories, (2) lenders and other businesses that buy reports from credit bureaus, and (3) parties who furnish consumer information to credit bureaus. Among other provisions, the FCRA limits the sale of credit reports by credit bureaus by requiring the purchaser to have a legitimate business need for the data, allows consumers to learn the information about them in credit bureau files (including one annual free credit report), and specifies procedures for challenging errors in that data.

Finance Charge

The total dollar amount paid to get credit.

Financing Fee

The fee a lender charges to originate a loan. The fee is based on a percentage of the loan amount; one point is equivalent to one percent.

First Mortgage

A mortgage that is the primary lien against a property that secures the mortgage and has predominant status over any others claims to the property, in the event of default.

First-Time Home Buyer

A person with no ownership interest in a principal residence during the three-year period preceding the purchase of the property used as collateral for the loan.

Fixed Interest Rate

A traditional approach to determining the finance charge payable on an extension of credit. A predetermined and certain rate of interest is applied to the principal.

Foreclosure

The legal process used to force the payment of debt secured by collateral whereby the property is sold to satisfy the debt.

Graduated Payment

Repayment terms calling for gradual increases in the payments on a closed-end obligation. A graduated payment loan usually involves negative amortization.

Home Equity Line of Credit (HELOC)

Is an “open-end” line of credit that allows you to borrow repeatedly against your home’s equity. You “draw” on the line over time, usually up to some credit limit, using special checks or a credit card. As you repay the principal, you can draw that amount again. This part of the plan is known as the “draw period,” which usually lasts for some fixed term, such as ten years. After the draw period ends, you typically then enter the “repayment period,” during which you must pay off the outstanding balance in regular periodic payments of principal and interest. The repayment period is also a fixed term of years.

Installment Plan

A plan requiring a borrower to make payments at specified intervals over the life of a loan.

Interest

A fee for the use of money over time. It is an expense to the borrower and revenue to the lender. Also money earned on a savings account.

Interest Payments

The return expressed in percentage earned on an investment each year. These payments are issued every six months based on an annual rate.

Interest Rate

The percentage charged for a loan, usually a percentage of the amount lent. Also, the percentage paid on a savings account.

Internet Banking

Usually conducted through a personal computer (PC) that connects to a banking Web site via the Internet. Internet banking can also be conducted via wireless technology through either personal digital assistants (PDAs) or cellular phones.

Lien

A creditor's claim against a property, which may entitle the creditor to seize the property if a debt is not repaid.

Liquidity

A quality that makes an asset easily convertible into cash with relatively little loss of value in the conversion process. Sometimes used more broadly to encompass credit in hand and promises of credit to meet needs for cash.

Liquidity Risk

In banking, risk that a depository institution will not have sufficient cash or liquid assets to meet borrower and depositor demand.

Lock-In Rate

A written agreement that the mortgage interest rate will not change between the offer date and the closing date, as long as the loan is closed within a specific time period (i.e.-45 days) and there are not any changes to the loan application.

Manufactured Housing

Homes that are built entirely in a facto-ry in accordance with a federal building code administered by the U.S. Department of Housing and Urban Development (HUD). Manufactured homes may be single or multi-section and are transported from the factory to a site and installed. Homes that are permanently affixed to a foundation often may be classified as a real property and may be financed with a mortgage. Homes that are not permanently affixed to a foundation generally are classified as personal property, and are financed with a retail installment sales agreement.

Maturity

The time when a note, bond or other investment option comes due for payment to investors.

Mortgage

A temporary and conditional pledge of property to a creditor as security for the repayment of a debt.

Mortgage Insurance (MI)

Insurance that protects lenders against losses caused by a borrower’s default on a mortgage loan. MI typically is required if the borrower’s down payment is less than 20 percent of the purchase price.

Mortgage Insurance Premium (MIP)

The amount paid by a borrower for mortgage insurance, either to a government agency such as the Federal Housing Administration (FHA) or to a private mortgage insurance (PMI) company.

Mortgage Life Insurance

A type of insurance that will pay off a mortgage if the borrower dies while the loan is outstanding; a form of credit life insurance.

Negative Amortization

A situation that can occur on some interest-bearing loan accounts, such as a mortgage loan, when the outstanding balance increases because the borrower is not paying enough to cover the interest charges that have accrued between payments and the remaining interest owed is added to the loan’s principal balance.

Net Worth

The difference between the total assets and total liabilities of an individual.

Nominal interest rates

Current stated rates of interest paid or earned.

Office of the Comptroller of the Currency (OCC)

Established as a bureau of the Treasury Department, the Office of the Comptroller of the Currency (OCC) charters, regulates, and supervises all national banks. It also supervises the federal branches and agencies of foreign banks.

Open-End Credit

A line of credit that may be used repeatedly up to a certain limit, also called a charge account or revolving credit.

Open-End Lease

A lease that may involve a balloon payment based on the value of the property when it is returned. Also called finance lease.

Origination Fee

A fee some lenders charge for submitting, processing and evaluating a proposed mortgage loan.

Overdraft Checking Account

A checking account associated with a line of credit that allows a person to write checks for more than the actual balance in the account, with a finance charge on the overdraft.

Points

In reference to a loan, points consist of a lump sum payment made by the borrower at the outset of the loan period. Generally, each point equals one percent of the loan amount.

Prime Rate

The lowest interest rate on bank loans, offered to preferred borrowers.

Principal

The unpaid balance on a loan, not including interest; the amount of money invested.

Promissory Note

A written promise on a financial instrument to repay the money plus interest.

Real Interest Rates

Interest rates adjusted for the expected erosion of purchasing power resulting from inflation. Technically defined as nominal interest rates minus the expected rate of inflation.

Renegotiable Rate

A type of variable rate involving a renewable short- term "balloon" note. The interest rate on the loan is generally fixed during the term of the note, but when the balloon comes due, the lender may refinance it at a higher rate. In order for the loan to be fully amortized, periodic refinancing may be necessary.

Right of First Refusal

A provision in an agreement that requires the owner of a property to give another party the first opportunity to purchase or lease the property before he or she offers it for sale or lease to others.

Seller's Points

In reference to a loan, seller's points consist of a lump sum paid by the seller to the buyer's creditor to reduce the cost of the loan to the buyer. This payment is either required by the creditor or volunteered by the seller, usually in a loan to buy real estate. Generally, one point equals one percent of the loan amount.

Servicing

The tasks a lender performs to protect the mortgage investment, including the collection of mortgage payments, escrow administration and delinquency management.

Service Charge

A component of some finance charges, such as the fee for triggering an overdraft checking account into use.

Settlement

The process of completing a loan trans-action at which time the mortgage doc-uments are signed and then recorded, funds are disbursed, and the property is transferred to the buyer (if applicable). Also called “closing or escrow” in different jurisdictions.

Short-term Interest Rates

Interest rates on loan contracts or debt instruments such as Treasury bills, bank certificates of deposit or commercial paper that have maturities of less than one year.

Simple Interest

Interest that is paid only on the original amount borrowed for the length of time the borrower has use of the credit. The amount borrowed is referred to as the principal. In the simple interest rate calculation, interest is computed only on that portion of the original principal still owed.

Short Sale

Where the bank, or lender, agrees to accept less than the amount due on a mortgage loan in order to make the sale of the house possible. This may have some tax implications for the borrower.

Term

The period from when a load is made until it is fully paid.

Terms

Provisions specified in a loan agreement.

Thrift Institution

A general term encompassing savings banks, savings and loan associations, and credit unions.

Title Insurance

Insurance to protect the lender (lender’s policy) or the buyer (owner’s policy) against loss arising from disputes over ownership of a property.

Transaction Account

A checking or similar account from which transfers can be made to third parties. Demand-deposit accounts, negotiable order of withdrawal (NOW) accounts, automatic transfer service (ATS) accounts, and credit union share draft accounts are examples of transaction accounts at banks and other depository institutions.

Truth in Lending Act

The popular name for the Consumer Credit Protection Act passed in 1989. This federal law requires disclosures of credit terms using a standard format.

Underwriting

The process used to determine loan approval. It involves evaluating the property and the borrower’s credit and ability to pay the mortgage.

USPAP

Uniform Standards of Professional Appraisal Practice used as guidelines for appraisers.

Variable Rate

A variable-rate agreement, as distinguished from a fixed-rate agreement, calls for an interest rate that may fluctuate over the life of the loan. The rate is often tied to an index that reflects changes in market rates of interest. A fluctuation in the rate causes changes in either the payments or the length of the loan term. Limits are often placed on the degree to which the interest rate or the payments can vary.

Wraparound

A financing device that permits an existing loan to be refinanced and new money to be advanced at an interest rate between the rates charged on the old loan and the current market interest rate. The creditor combines or "wraps" the remainder of the old loan with the new loan at the intermediate rate.

Walk-Through

A buyer’s final inspection of a property, usually conducted right before closing, to determine that the property is as described in the purchase agreement. For example, within the 24 hours before closing.

Warranties

Written guarantees of the quality of a product and the promise to repair or replace defective parts free of charge.

Yield

The return on a loan or investment, stated as a percentage of price.

Zoning

A county or city law stating the types of use to which properties can be put in specific areas.