Friday, October 03, 2008

A Fast Lesson In Mortgage Terminology

Adjustable Rate Mortgage (a.k.a. ARM Loan): An Adjustable Rate Mortgage is a home loan where the interest rate adjusts throughout the term of the loan. ARM Loans usually have an initial interest rate that is lower than that of a Fixed-Rate Mortgage. This low interest rate is locked for a set length of time. Once that time has expired, the interest rate can go up based on market factors. The lower initial interest rate helps those who can't afford a fixed-rate mortgage get financing for their home. However, the interest rate will most likely increase after the initial term of the low interest rate expires.

Annual Percentage Rate (APR): APR is the interest rate quoted by the lender plus additional home loan costs. Additional costs include origination fees, points, etc. APR is often higher than the stated interest rate. This is because the additional costs will alter the originally advertised interest rate accordingly.

Bridge Financing. A method of financing, used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash. Bridge financing is commonly used when the cash flow from a sale of an asset is expected after the cash outlay for the purchase of an asset. For example, when selling a house, the owner may not receive the cash for 90 days, but has already purchased a new home and must pay for it in 30 days. Bridge financing covers the 60 day gap in cash flows.

Another type of bridge financing is used by companies before their initial public offering, to obtain necessary cash for the maintenance of operations. These funds are usually supplied by the investment bank underwriting the new issue. As payment, the company acquiring the bridge financing will give a number of stock at a discount of the issue price to the underwriters that equally offsets the loan. This financing is, in essence, a forwarded payment for the future sales of the new issue.

Bridge financing may also be provided by banks underwriting an offering of bonds. If the banks are unsuccessful in selling a company's bonds to qualified institutional buyers, they are typically required to buy the bonds from the issuing company themselves, on terms much less favorable than if they had been successful in finding institutional buyers and acting as pure intermediaries.

There are 2 types of bridging finance. Closed bridging and Open Bridging.

Closed bridging finance is where you have a date for the exit of the bridging finance and are sure that the bridging finance can be repaid on that date. This is less risky for the lender and thus the interest rate charged are lower.

Open bridging is higher risk for the lender. This is where the borrower hasn't got an exact date for the bridging finance exit and may be looking for a buyer of the property or land.

Closing Costs: Closing costs are the expenses involved in finalizing a mortgage. Closing costs include lender/agency fees, loan origination costs, escrow payments, title insurance, attorney fees, etc. Closing costs are often shared between both the buyer and the seller.

Escrow: Escrow is at the end of the mortgage process where a neutral third party obtains the documentation and money involved in the transaction until the transaction is complete. An escrow account is also used to hold the property tax and insurance monies that are collected during payment of the loan.

Fixed-Rate Mortgage: A fixed-rate mortgage is a loan where the interest rate stays the same. It does not fluctuate while the loan is being paid off. Financing for fixed-rate mortgage loans are commonly spread out over 10, 15, 20, or 30 years. This type of loan is popular because there are typically no surprises. Since the interest rate remains the same, the monthly mortgage payments are static, and don't change year to year.

Points: Points are a percentage of the principal of the loan used to lower the interest rate of a loan. There are two types of points: Discount Points and Origination Points. Discount Points reduce the interest rate of a loan by having the lender pay more at closing. One point equals one percent. So, if you want to lower your interest rate by one percent, the borrow needs to pay one percent of the principal at closing. However, this does not lower the principal amount. It merely lowers the interest rate. Origination Points are used is the same fashion and utilized to cover the loan processing expenses.

Principal: Principal is the original amount borrowed from the lender. It does not include interest or other fees. It's the lump sum the borrower gets from the lender.

Knowing the lingo involved in your mortgage will help you stay on top of the mortgage process and allow the entire process to run smoothly. Read up on these terms and keep yourself out of the dark.



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