GLOSSARY

ADJUSTABLE RATE MORTGAGE (ARM)
Also known as a Variable Rate Mortgage (VRM). A mortgage where the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly. The note rate equals the rate at the beginning of the loan. The contract rate is determined by adding the interest rate and the margin at specified adjustment periods.

Lenders generally charge lower initial interest rates, (note rate) for ARMs than for fixed-rate mortgages. This makes the ARM easier on the borrower's pocketbook at first than a fixed-rate mortgage of the same amount. It also means that the borrower might qualify for a larger loan because lenders sometimes make this decision on the basis of the borrower's current income and the first year's payments. Moreover, an ARM could be less expensive over a long period than a fixed-rate mortgage. For example, if interest rates remain steady or decrease.

Against these advantages, the borrower must weigh the risk that an increase in interest rates would lend to higher monthly payments in the future. There is a trade off - the borrower gets a lower rate with an ARM mortgage in exchange for assuming more risk.

For more information, read the Consumer Handbook on Adjustable Rate Mortgages (CHARM) booklet put out by the Federal Reserve Board and the Federal Home Loan Bank Board.

ADJUSTMENT PERIOD
With most ARMs, the interest rate and monthly payment change every year, every three years or every five years. However, some ARMs have more frequent interest and payment changes. The period between one rate changes and the next is called the adjustment period. So a loan with an adjustment period of one year is called a One Year ARM and the interest rate can change once every year.

AMORTIZATION
Repayment of a loan in installments.
ANNUAL PERCENTAGE RATE (APR)
A measure of the cost of credit, expressed as a yearly rate. It includes interest as well as other charges. Since all lenders follow the same rules to ensure the accuracy of the annual percentage rate, it provides borrowers with a good basis for comparing the cost of loans, including mortgage plans.

The APR is similar to the Unit Price used by supermarkets to give borrowers a benchmark by which they can compare similar products.

MUST BE DISCLOSED ON ALL FIRST MORTGAGES WITHIN 3 DAYS OF THE DATE THE APPLICATION IS TAKEN.

Calculated as:

* Using the present value of the loan amount, the term of the loan (# of monthly payments over life) and interest rates, solve for monthly payments of principle and interest.
* Now, take loan amount, and subtract all pre-paid finance charges1 to determine a New Present Value (loan amount - all prepaid finance charges = New Present Value).
* Next, using the same principle and interest payments figured earlier and the same term of the loan (# of Monthly Payments over life) originally used, solve for a new interest rate.
* The new interest rate is the APR.
APPLICATION
An application has been made on a First Mortgage when this information is collected from a borrower:

1. The approximate loan amount
2. The approximate income of the borrower
3. The approximate purchase price of the home or
4. The Loan to Value ratio.
5. The borrower's approximate long term debts
6. The borrower's taxes
7. The borrower's insurance payments

This application information can be done over the phone, in person, by fax, etc.

EVEN IF NO FORMAL APPLICATION FORMS IS FILLED OUT, OR IF YOU ARE TRYING TO GET A PRE-APPROVED LOAN, THIS IS STILL CLASSIFIED AS HAVING TAKEN AN APPLICATION.

Upon taking an application:

* The lender must give the borrower a Good Faith Estimate of the costs to finance the loan
* The lender must disclose the APR within 3 days
* The lender must give or send the borrower, IMMEDIATELY, a copy of the HUD Guide to Settlement Costs
* The lender must give or send the borrower, IMMEDIATELY, a loan disclosure which describes the program discussed, i.e., Buydowns, ARMs, etc.
* If an ARM is discussed, the lender must give or send the borrower, IMMEDIATELY, a copy of the Consumer Handbook on Adjustable Rate Mortgages (CHARM)

ASSUMABILITY
When a home is sold, the seller may be able to transfer the mortgage to the new buyer. This means the mortgage is assumable. Lenders generally require a credit review of the new borrower and may charge a fee for the assumption. Some mortgages contain a Due on Sale clause, which means that the mortgage may not be transferable to a new buyer. Instead, the lender may make the borrower pay the entire balance that is due when the some is sold. Assumability can help the seller attract buyers when he/she sells his/her home.
BALLOON MORTGAGE
A mortgage with a fixed amortization period for a fixed period of time. At the end of the time period, all of the outstanding balance (a Balloon Payment) is due prior to the actual amortization for that loan period.

For example:
FNMA 7/23 Program - For the first seven years of the loan, payments are made as if they are financed over 30 years at a rate lower than the current market rate. At the end of seven years, a Balloon Payment could be made, or the remaining principle could be refinanced at the current rate over a new time period.

BALLOON PAYMENT
Large final payment, as when a loan is repaid in installments with the final payment being different than the rest.

BASIS POINT
A basis point is equal to one one-hundredth of one percent (1/100 x .01%) or one one-hundredth of one point. See also, Points.

BUYDOWN
With a Buydown, the seller pays an amount to the lender so that the lender can give you a lower rate and lower payments. The seller may increase the sales price to cover the cost of the Buydown. See also Temporary Buydown and Permanent Buydown (no difference for ARMs).

CAP
A limit on how much the interest rate or the monthly payment can change, either at each adjustment or during the life of the mortgage. Payment caps don't limit the amount of interest the lender is earning, so they may cause negative Amortization. See also, Interest Rate Caps and Payment Caps.

COLLATERAL
Assets that are pledged as security for payment of debt.

COMPOUND INTEREST
Interest that is charged both on the initial principle and on interest charged on the initial principle in previous periods. The interest charged in one period becomes in effect part of the principle in a following period. See also Compounding.

COMPOUNDING
Process of recharging each interest payment to earn more interest. Compounding is based on the idea that interest itself becomes principle and therefore also earns interest in subsequent periods. See also Compound Interest.
COMPOUND VALUE
Value of a sum after earning interest over one or more periods. Also called Future Value.

CONSOLIDATION
A merger in which an entirely new entity is created. i.e. Debt Consolidation.

CONTRACT RATE
The rate of interest charged on the re-payment of a loan during the duration of the re-payment. See Note Rate.

Example:
* Fixed Rate Loan at 8%-Contract Rate=8%; Contract Rate = Note Rate
* Fixed Rate Buydown (10% to 7%) - Contract Rate = 10%. Rate for 1st year = 7% (note rate), 2nd year = 8%, 3rd year = 9%, 4th year and duration of loan = 10% (contract rate)
* Adjustable Rate Mortgage (6.5%) - Contract Rate starts at 6.5%, may vary at specified periods throughout the term of the loan. Note Rate - 6.5%

CONVERSION
The borrower's agreement with the lender can have a clause that lets the borrower convert an ARM to a Fixed Rate Mortgage at designated times. When converted, the new rate is generally set at the current market rate for Fixed Rate Mortgages.

CONVERSION CLAUSE
A provision in some ARMs that allows the borrower to change the ARM to a fixed rate loan at some point during the term. Usually, conversion is allowed at the end of the first adjustment period. At the time of the conversion, the now fixed rate is generally set at one of the rates then prevailing for Fixed Rate Mortgages. The conversion feature may be available at an extra cost.

DISCOUNT
Some lenders offer initial rates on ARMs and Fixed Rate Mortgages that are lower than other current rates. Such rates, called Discounted Rates, are often combined with large initial loan fees (Discount Points). These discounted rates are also known as buydowns.

DUE ON SALE
See Assumability.
INDEX
Most lenders tie ARM interest rate changes to changes in an Index Rate. These indexes usually go up and down with general movement of interest rates. If the Index Rate goes up, so does the borrower's mortgage rate, and, in most circumstances, and will probably have to make higher monthly payments. On the other hand, if the Index Rate goes down, the borrower's monthly payment may go down.

Lenders base ARM rates on a variety of indexes. Among the most common are the rates on one, three, and five year Treasury Securities. Another common index is the National or Regional average cost of funds to savings and loan associations. A few lenders use their own cost of funds, over which, unlike other indexes, they have some control. The borrower should ask what index will be used and how often it changes. Also, they should ask how it has behaved in the past and where it is published.

INTEREST RATE CAPS
An Interest Rate Cap places a limit on the amount your interest rate can increase. Interest caps come in two versions:

* Periodic Caps - which limit the interest rate increase from one adjustment period to the next.
* Overall Caps - which limit the interest rate increase over the life of the loan.

By law, virtually all ARMs must have an Overall Cap. Many have a Periodic Interest Rate Cap.

MARGIN
To determine the interest rate on an ARM, lenders add to the Index Rate, a few percentage points, called the Margin. The amount of the Margin can differ from one lender to another, but it is usually constant over the life of the loan.

NEGATIVE AMORTIZATION
If a borrower's ARM contains a Payment Cap, be sure to find out about Negative Amortization. Negative Amortization means the mortgage balance is increasing. This occurs whenever your monthly mortgage payments ar not large enough to pay all of the interest due on your mortgage.

This is so because payment caps limit only the amount of payment increases and not interest.

NOTE RATE
The rate of interest charged on the repayment of a loan at the beginning of repayment. See Contract Rate.

Example:
* Fixed Rate Loan at 8% - Note Rate=8%; Note Rate=Contract Rate
* Fixed Rate Buydown (10% to 7%) - Note Rate=7%; Rate for 1st year =7%, 2nd year = 8%, 3rd year = 9%, 4th year and duration 10%. 10% = Contract Rate.
* Adjustable Rate Mortgage (6.5%) - Note Rate = 6.5%, contract rate changes from period to period.

PAYMENT CAP
Some ARMs include Payment Caps which limit the borrower's monthly payment increase at the time of each adjustment, usually to a percentage of the previous payment. In other words, with a 7.5% payment cap, a payment of $100.00 could increase to no more than $107.50 in the first adjustment period, and to not more than $115.56 in the second. See also Negative Amortization.

PER DIEM RATE (Daily Rate)
A calculation of interest made on daily payments. Usually used for the interim period between the date the contract is made and the beginning of the next month, when the first payment is made.

Calculated As:
1. Take the present value of the loan amount, multiply it by the Note Rate.
2. Now, take result, divide that number by 365 to determine the Per Diem Rate.
* For disclosure purposes, solve for the worst case scenario - one full month - per diem rate x 30 days (1 month) = pre-paid interest.

PERMANENT BUYDOWN
The borrower pays a loan fee (Discount Points) or a seller buydown to make a lower rate and lower payments for the duration of the loan.

Fixed Rate Mortgage - Discount points (higher than in temporary buydown) paid as a fee at time of loan. A new rate is established for the loan, For example, by paying more points, a customer can buy a 10% rate down to 9.5%. (Note Rate = Contract Rate).

Adjustable Rate Mortgage - Discount points paid as a fee at time of loan to lower the note rate of the loan.

See also Temporary Buydown.
POINT
A point is equal to one percent of the principal amount of your mortgage. For example, if the borrower gets a mortgage for $65,000, one point means he/she pays $650.00 to the lender. Lenders frequently charge points in both fixed-rate and adjustable-rate mortgages in order to increase the yield on the mortgage and to cover loan closing costs. These points usually are collected at closing and may be paid by the borrower or the home seller, or may be put between them. See also, Basis Points.

PRE-PAYMENT
Some mortgage agreements may require the borrower to pay special fees or penalties if the borrower pays off the mortgage early. Many mortgages allow the borrower to pay the loan in full or in part without penalty whenever the rate is adjustable. Pre-payment details are sometimes negotiable. If so, the borrower may want to negotiate for no penalty or for as low a penalty as possible.

TEMPORARY BUYDOWN
The borrower pays a loan fee (Discount Points) or a seller buydown to make a lower initial rate and low payments early in the term.

Example:

Fixed Rate Mortgage - (10% Mtg. w/Temporary Buydown to 7%) - Discount Points paid as a fee at time of loan. Rate for first year = 7%, 2nd year = 8%, 3rd year = 9%, 4th and duration of loan = 10%.

Adjustable Rate Mortgage - Discount points paid as a fee at time of loan to lower the note rate of the loan.

VARIABLE RATE MORTGAGE (VRM)
See also, Adjustable Rate Mortgage (ARM).

Castle Mortgage Corporation is a licensed First and Second Mortgage Lender in the State of Connecticut. Equal Housing Lender. Equal Opportunity Lender.

Last modified on Monday, July 15, 1996