Adjustable Rate Mortgage – A type of mortgage where the interest rate is only fixed for a specific time period (usually 1, 3, 5, 7, or 10 years), after which it will be tied to an index (LIBOR and Prime Rate are two such indices) and adjust accordingly. Payments increase or decrease monthly or annually based on the adjusting interest rate. An ARM transfers some risk to the borrower from the lender, so to offset this shift, the initial fixed rate is often percentages lower than the average long term fixed rate. They also usually come with an adjustment “cap” or “ceiling” which acts as a maximum threshold for how high your interest rate can rise. If you plan on staying in your home for a short period of time (a few years) or if you expect a large increase in income in the future, an ARM is probably the best choice. Also, for individuals taking out loans when interest rates are high, an adjustable rate mortgage would allow an individual to take advantage of lower rates in the years to come.

Amortization – The process of eliminating debt by paying off a loan gradually with interest and principal payments.

Annual Percentage Rate (APR) – The yearly interest rate that reflects the total cost of the mortgage. The APR is likely to be higher than the quoted interest rate because it includes acquisition fees, points, insurance, and other credit and closing costs. Lenders are required by law to make the APR of the mortgage known and it is therefore a good way for borrowers to compare loan variations based on yearly costs.

Balloon Payment – A balloon payment is a lump sum due by the end of the loan, which will pay off the outstanding principle balance.

Cap – The highest allowable increase in interest rates for an adjustable rate mortgage. Caps create a ceiling above which the interest rate may not rise.

Cash Out – The process of taking additional money out of your property during a refinance either through a home equity loan or by refinancing for greater than the current balance of your mortgage. Taking this extra money out of your property may increase your interest rates because trends support the theory that cashing out increases the chance of a borrower defaulting on their loan.

Closing Costs – Costs, ranging from 1%-5% of a home’s purchase price, paid by the borrower at the closing of a transaction. When you are purchasing a property, you will have to pay the closing costs at the time when ownership of the property transfers to you. These costs include but are not limited to points, appraisal fee, title insurance, and fees for preparing and filing a mortgage.

Conforming Loan – A mortgage loan conforming to the guidelines of Fannie Mae and Freddie Mac. Any loan which is below the guideline’s limit will have a lower interest rate than larger, nonconforming loans. Fannie Mae and Freddie Mac will purchase these loans and sell them on the secondary markets.

Conventional Loan – A mortgage not insured or guaranteed by the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), or the Farmers Home Administration (FmHA).

Discount Points – An amount, in excess of the one percent mortgage origination fee, paid to the lender to reduce the interest rate of a loan. A point equals one percent of the total value of the loan.

Down Payment – The amount of money put down in cash, not financed by a lender, when a buyer purchases a property. The larger the down payment, the better deal one can negotiate on their mortgage.

Equity – The difference between the market value of a property and the debt owed against it.

Fannie Mae – The Federal National Mortgage Association, a government sponsored entity, which purchases home loans which adhere to its rigid standards. Fannie Mae, or FNMA, combines these mortgages into loan instruments which it sells to outside investors. These loan bundles are considered safe because Fannie Mae, and thus the government, guarantees the repayment of the principal and interest.

FHA – The Federal Housing Administration, a government agency, whose role it is to insure mortgages made by private lenders to low and moderate income households. By insuring these mortgages, FHA enables a person to receive a loan while paying only a smaller down payment and a low interest rate, but not all loans conform to the standards of FHA.

First Mortgage – A mortgage which has first claim against a property before any other mortgages. Also known as a senior mortgage, this mortgage must be paid off first in the case of default.

Fixed Rate – An interest rate which does not change for the length of the loan.

Fixed Rate Mortgage – A type of mortgage where the interest rate is fixed over the life of the loan. Because the interest rate is fixed, the monthly payments are also fixed, making it easier to budget for the future. The most common payment terms are 15-, 20-, and 30-year time spans. Usually the longer the term is, the higher the interest rate and therefore the greater your total mortgage cost. However, you will also usually see that the longer the mortgage, the lower your monthly payment. If you plan on staying in your home for the duration of your mortgage and don’t expect much income fluctuation, an FRM is probably the right choice. Also, for individuals taking out loans when interest rates are very low, a fixed rate mortgage would allow the borrower to lock in that low rate for the duration of their loan, making fluctuations inconsequential.

Freddie Mac – The Federal Home Loan Mortgage Corporation or Freddie Mac purchases home loans which adhere to its rigid standards. Freddie Mac combines these mortgages into loan securities which it sells to outside investors. These loan instruments are considered safe because Fannie Mae guarantees the repayment of the principal and interest.

Interest-Only Mortgage – An interest-only mortgage is a non-amortized loan where only the interest is paid back at regular intervals. The principal sum is paid back at the end of the mortgage usually via an investment vehicle such as a pension, PEP, or ISA.

Jumbo Loans – A jumbo loan is a loan for homebuyers requiring a very large sum of money, sometimes ranging into the millions of dollars. They are available as both fixed and adjustable rate mortgages and generally hold higher interest rates due to the size of the loan. At this time, any loan over $203,150 is considered to be a jumbo loan.

Interest Rate – A percentage of the principal paid in periodic installments for use of credit.

LIBOR – The London Inter-Bank Offered Rate is the rate at which London banks lend US dollar deposits to one another in the London money market. Domestic banks often tie adjustable rate mortgages to LIBOR, as it is an index that quickly adjusts to fluctuating interest rates and accurately reflects current market conditions.

Loan to Value Ratio (LTV) – The relationship of a mortgage on a property to the property’s true value. Essentially, the loan amount expressed as a percentage of either the purchase price or the appraised value of the home. For example, if you’re buying a home that’s appraised at $250,000 and your mortgage is $200,000, the LTV is .8 or 80%.

Lock/Lock In – A lender’s written contract guaranteeing a specific interest rate over the life of the loan to the borrower as long as the loan is closed by a certain time. The downside to locking in an interest rate is that the borrower may have to pay a slight interest rate premium.

Margin – An amount added to the index which is used to determine the interest rate for an adjustable rate mortgage. The margin usually is between 2-3% and does not change over the whole loan term (whereas the index fluctuates).

Minimum Payment – The lowest amount a borrower must pay, typically monthly, to keep an account from defaulting.

Mortgagee – The party lending money in a mortgage transaction.

Mortgagor – The party borrowing money in a mortgage transaction.

Mortgage Loan Guidelines – The mortgage that’s best for you is the one you can reasonably afford for the length of time you plan to stay in your home. Should you schedule to repay the loan in 15 years? 20 years? 30 years? It usually holds true that the shorter the time span, the more you will save on interest payments. But of course, the longer the term of repayment, the lower your monthly payments will be. So when choosing a loan duration, make sure to consider your income over the span of the loan, your monthly and yearly budget, spending patterns, and of course, how long you intend to stay in your home.

Negative Amortization – Negative amortization occurs when the payment installments fail to cover the interest or the principal, and thus the entire balance owed increases.

Origination Fee – A fee charged to the borrower and paid to either the federal government (for federal loans) or to the originator of the loan (for private loans). The fee covers the cost of administering and insuring the loan.

PITI – Principal, interest, taxes and insurance. PITI indicates the breakdown of your monthly mortgage payments and are the four major components of your loan.

Prepayment Penalty – Fees used to dissuade early repayment of a loan or mortgage.

Principal – The total loan amount borrowed. If you borrow $200,000, then your principal is $200,000. With each payment you will pay off interest the lender is charging you for the principal amount.

Private Mortgage Insurance (PMI) – Insurance which protects the lender should a borrower default on the loan. PMI is required when the down payment on a property is less than 20% of the property’s price and can add hundreds of dollars to the annual loan cost.

Right to Rescission – A provision defined in the Federal Truth in Lending Act that gives borrowers the right to cancel or opt out of their mortgage contract within three days of the agreement.

VA Loan – Loans offered by the Department of Veterans Affair and designed to help qualified people (active duty military personnel, veterans of military service, eligible spouses) purchase primary homes. As long as the residence’s purchase price is below a certain level, VA loans require no down payment. VA loans also charge an interest rate typically 1% below the conventional loan rate.

Variable Rate – An interest rate that is tied to an index and adjusts periodically over the loan’s term.