A Short Glossary of Mortgage Terms

The mortgage banking and lending industry is huge and rather complex and, not surprisingly, it has its own language. To help you make some sense of all the loan and mortgage verbiage you may have come across, we have compiled a brief glossary for you.

Adjustable-Rate Mortgage (ARM): A mortgage where the interest rate is not fixed, but changes during the life of the loan in line with movements in an index rate. You may also see ARMs referred to as AMLs (adjustable mortgage loans) or VRMs (variable-rate mortgages).

Amortization: A payment plan which enables the borrower to reduce his debt gradually through monthly payments of principal.

Annual Percentage Rate (APR): A measure of the cost of credit, expressed as a yearly rate. It includes interest as well as other charges. Because all lenders follow the same rules to ensure the accuracy of the annual percentage rate, it provides consumers with a good basis for comparing the cost of loans, including mortgage plans.

Conversion Option: Some ARMs come with options to convert them to a fixed rate mortgage during a given time period without having to go through a refinancing, which could cost up to five or six percent of the loan amount. The interest rate or points may be somewhat higher for a convertible ARM. Also, a convertible ARM may require a small fee at the time of conversion.

Discount: In an ARM with an initial rate discount, the lender gives up a number of percentage points in interest to give you a lower rate and lower payments for part of the mortgage term (usually for one year or less). After the discount period, the ARM rate will probably go up depending on the index rate.

Encumbrance: A legal right or interest in land that affects a good or clear title, and diminishes the land's value. It can take numerous forms, such as zoning ordinances, easement rights, claims, mortgages, liens, charges, a pending legal action, unpaid taxes, or restrictive covenants. An encumbrance does not legally prevent transfer of the property to another. A title search is all that is usually done to reveal the existence of such encumbrances, and it is up to the buyer to determine whether he wants to purchase with the encumbrance, or what can be done to remove it.

Equity: The value of a homeowner's unencumbered interest in real estate. Equity is computed by subtracting from the property's fair market value the total of the unpaid mortgage balance and any outstanding liens or other debts against the property. A homeowner's equity increases as he pays off his mortgage or as the property appreciates in value.

Jumbo Loans: Non-conforming loans that exceed Fannie Mae and Freddie Mac guidelines. Can be for up to $6 million and more.

Loan-to-Value Ratio (LTV): The relationship between the amount of the mortgage loan and the value of the real property expressed as a percentage. For purchase loans the value of the property is the appraised value or the purchase price, whichever is less. For refinance loans the value is the appraised value.

A LTV of 90% means that you can borrow a maximum of 90% of the property value. If a LTV exceeds 80%, Private Mortgage Insurance (PMI) is generally required.

No Doc Loans: Also known as no documentation loans, they do not require income, asset or employment verification. These loans are based on the value of your home, the quality of your credit and your middle credit score.

No Ratio Loan: Good loans for those who can verify employment for two years in the same industry (ideally the same or similar job), but do not want to verify income. They require employment verification and asset verification for purchases, but rarely require verification of assets for refinances.

Non-conforming loan: Loans that do not comply with Fannie Mae or Freddie Mac guidelines. These guidelines establish the maximum loan amount, down payment, borrower credit and income requirements, and suitable properties.

PITI: Principal, Interest, Taxes and Insurance. These components are usually included in the monthly mortgage payment.

Private Mortgage Insurance (PMI): An insurance policy the borrower buys to protect the lender from non-payment of the loan.

Stated Income Loan: Sometimes referred to as "no income" or "no income verification" loans, they are an ideal mortgage for the self-employed or for people who receive much of their income in commissions or bonuses.

Title Insurance: Protects lenders or homeowners against loss of their interest in property due to legal defects in title. Title insurance may be issued to a "mortgagee's title policy." Insurance benefits will be paid only to the "named insured" in the title policy, so it is important that an owner purchase an "owner's title policy", if he desires the protection of title insurance.

Two-Step Mortgage: With this type of loan homebuyers get a fixed rate loan at a slightly lower interest rate for a fixed period of time (most often for 5, 7, or 10 years) and then the interest rate is adjusted to fit market conditions at that time. After that adjustment, the mortgage maintains a fixed rate for the remaining years.

Wraparound Mortgage: A loan arrangement whereby the existing loan is retained and a new loan is added to the property. Full payments on both mortgages are made to the wraparound mortgagee, who then forwards the payments on the first mortgage to the first mortgagee.