- Accrued
interest
- Accrued
interest is the interest expense that accumulates on your
loan. For example, if you have a monthly loan at an annual
interest rate of 12%, interest accrues at the rate of 1
percent per month. If your loan balance is $5,000, the
accrued interest after one month is 1 percent of the loan
amount, or $50. If you make a loan payment of $100, $50
will be applied to the accrued interest and $50 to
reducing loan principal. In order to pay down more of your
loan, you must increase your loan payment to reduce the
share that is paid to accrued interest. {top}
- Adjustable-rate
mortgage
- Adjustable
rate mortgages are called ARMs for short. The lender
changes the interest rate periodically in accordance with
the loan agreement. For example, the loan agreement may
say that the rate on a 1-year ARM is reset every Sept. 1
after an initial period of three years. The interest rate
is calculated by adding a margin to an index rate. If the
margin is 3 percentage points and the yield on the 1-year
bill (assumed to be the index rate) is 6%, the loan rate
is reset to 9%. ARM loans usually have provisions that
limit how much the loan rate can increase at one resetting
and over the term of the loan. {top}
- Adjustment
period
- The
adjustment period is the frequency that the lender adjusts
the interest rate on a variable-rate mortgage loan. For
example, a 1-year ARM would have an adjustment period of
one year. {top}
- Aggressive
qualification estimate
- Mortgage
lenders are more aggressive when the economy is strong. As
a result, they tend to lower their loan-qualification
requirements to make it easier to qualify for loan.
{top}
- Amortization
- Amortization
is the gradual reduction of loan principal that occurs as
you make periodic loan payments. Generally, the loan
principal is completely amortized with the final payment.
As you pay back the loan, an increasing amount of each
payment is applied to principal and a lesser amount is
applied to interest. Amortization is also a process of
spreading a cost that is incurred upfront over the term of
the loan or life of the asset. {top}
- Amortization
table
- Table
of factors that shows how loan principal is repaid based
on the interest rate and loan term.
{top}
- Anniversary
date
- Anniversary
date is the periodic date, usually once a year, that the
interest rate is reset on an adjustable-rate mortgage.
{top}
- Annual
percentage rate (APR)
- The
real cost that you pay to borrow, stated as a yearly
percentage of the loan amount. This is sometimes called
your effective borrowing cost. For auto and mortgage
loans, closing costs and discount points are added to
calculate APR. For example, if you pay $500 in closing
costs to obtain a $10,000 loan, the APR will be higher
than the interest rate since you are effectively borrowing
$9,500 but will owe $10,000. The Truth-in-Lending Act
requires the lender to disclose the APR to you. For credit
cards, the annual fee is often not included in the APR
calculation. As a result, an APR of a credit card is often
its simple interest rate. {top}
- Appraisal
value
- Appraisal
value is the market value of an asset that is derived from
the appraisal process. Depending on the asset, the method
used to appraise the asset will differ. For homes,
appraisers often use a method that includes recent sales
data of comparable homes. They may also use the
replacement method, which is the cost to replace the home
at today's prices. {top}
- Appreciation
rate
- Appreciation
rate is the yearly percentage rate that an asset increases
in value. For example, a home that you paid $150,000 three
years ago that is almost worth $200,000 today had an
average appreciation rate of 10%. After the first year,
the home was worth $165,000. After the second year, the
home was worth $181,500. And after the third year, the
home is worth just a little under $200,000.
{top}
- Base
rate
- The
interest rate that is used as a benchmark to set the
interest rate for borrowers. A base rate is sometimes
called an index rate. For example, if you obtain a
one-year adjustable-rate mortgage, your loan rate will be
reset once a year to a rate that equals the loan rate plus
a margin. Interest rates on credit cards are frequently
tied to a change in the prime rate, another popular base
rate used in consumer lending. {top}
- Break-even
point
- When
you refinance a mortgage, the decision is profitable if
you are able to pass the break-even point. At the
break-even point, the savings you receive from refinancing
equal the costs. A common break-even analysis is to
calculate how long you must live in a home after you
refinance in order to recover the closing costs you paid
to refinance. For investing in stocks and mutual funds,
break-even analysis is used to calculate the minimum sale
price that allows the buyer to recover the transaction
costs from buying the shares. For business operations, a
business reaches its break-even point when it generates
enough sales to pay for all its fixed costs. For each
additional dollar of sales, variable costs should be less
than a dollar. As a result, each dollar of sales past the
break-even point generates some profit.
{top}
- Closing
- Closing
is the final stage of the loan process that requires an
exchange of any funds due the other party and any
signatures for recording the transaction. Closing costs
are paid at the closing. {top}
- Closing
costs
- Closing
costs are the total expenses that the buyer pays at the
time a real estate transaction is completed. This stage of
the transaction is called "closing." Closing
costs include application, underwriting and
loan-origination fees; mortgage points; title search and
insurance; fees for related legal services; and costs to
fund an escrow account. For home mortgage loans, closing
costs generally range between 3 and 6 percent of the home
purchase price. {top}
- Conservative
qualification estimate
- Mortgage
lenders are more conservative when the economy is weak. As
a result, they tend to raise their loan-qualification
requirements to make it more difficult to qualify for
loan. {top}
- Cost-benefit
analysis
- For
autos: an analysis that compares the cheaper of a)
borrowing money to buy a car and paying the interest, with
b), paying cash for a car, and losing the opportunity to
earn a rate of return on the savings applied to the
purchase. For homes: an analysis that subtracts the
benefits of homeownership from the costs of homeownership
to obtain a net cost. Included in costs are mortgage
interest, discount points, closing costs, property taxes
and homeowners insurance, home maintenance costs, and any
private mortgage insurance (PMI). Included in benefits are
the tax savings on deductions for mortgage interest
(including points) and property taxes, and an increase in
equity that you receive either from repayment of the loan
principal or an appreciation in the value of your home.
{top}
- Cost-of-funds
index (COFI)
- The
11th District Monthly Weighted Average Cost of Funds Index
(COFI) is one of many indexes used by mortgage lenders to
adjust the interest rate on adjustable-rate mortgages (ARMs).
COFI reflects the actual interest expenses recognized
during a given month by all savings-institution members of
the Federal Home Loan Bank of San Francisco (Source: FHLB
of San Francisco). {top}
- Debt
ratio
- Lenders
use a debt ratio (also called debt-income ratio) to
approve loan applicants. Debt ratio equals combined
monthly debt payments divided by gross monthly income. For
example, combined monthly debt payments of $2,000 divided
by gross monthly income of $4,000 equals a debt ratio of
50%. {top}
Down
payment
- A
down payment is the cash you deposit towards the purchase
of a home, business property, or vehicle. The larger the
down payment, the less you need to borrow. For home loans,
a down payment of 20% of the home purchase price is
generally required to avoid private mortgage insurance.
The value of a trade-in vehicle is often used instead of a
down payment for purchasing a vehicle.
{top}
Effective
interest rate
- The
effective interest rate is your true interest-rate cost of
borrowing stated as an annual rate. It may be shown on an
after-tax basis, adjusting for a mortgage interest
deduction. The effective rate on a mortgage or consumer
loan includes fees, points and other charges that you pay
when you close the loan. The effective rate also includes
compounded interest. Higher closing costs or more frequent
compounding result in a higher effective interest rate.
{top}
Fees
- Fees
include mortgage points and expenses to underwrite and
originate a mortgage loan. One point equals 1% of the loan
amount. The IRS considers points to be a form of prepaid
interest. Expenses include fees for appraisal, title
search, recordation of documents, and conveyance taxes.
Total closing costs include these fees, prepaid interest
to the first mortgage payment, and prepayments for
homeowners insurance and property taxes.
{top}
Equity
- Real
estate: the residual ownership claim on a home's value.
Equity equals the fair market value of a home, less any
mortgage debt or other obligations. Stocks or businesses:
an ownership stake in a company. Shareholders equity is
equal to assets minus liabilities.
{top}
- Homeowners
insurance
- Also
called property insurance, homeowners insurance protects
the homeowner from weather-related damage, as well as
potential liability from events that occur on the
property. Lenders require homeowners insurance coverage to
protect the collateral that secures their loan. Some
homeowners insurance policies do not cover catastrophic
events such as tornadoes, hurricanes or floods. These
kinds of events generally require a separate insurance
policy. {top}
- Homeowners
Protection Act
- The
Homeowners Protection Act of 1999 requires home lenders to
cancel a requirement for private mortgage insurance (PMI)
if the borrower has equity of at least 22% in their home.
(This is equal to a loan-to-value ratio of below 78%.) The
law allows the borrower to request dropping PMI when
equity reaches 20% of home value. A current appraisal may
be required to ascertain the home value. For more
information, see the Web site of the U.S. Dept. of Housing
and Urban Development (www.hud.gov.)
{top}
- Housing
ratio
- Lenders
use housing ratio to approve loan applicants. Housing
ratio equals combined monthly mortgage payment divided by
gross monthly income. For example, a combined monthly
mortgage payment of $1,500 divided by gross monthly income
of $4,500 equals a housing ratio of 33%.
{top}
Impounds
for taxes and insurance
- Impounds
are payments that you make in advance for homeowner's
insurance premiums and real estate taxes. You make these
payments to an escrow account at loan closing, and
periodically replenish the account. An escrow agent pays
the local tax authority and insurer from this account.
Analyzers calculate impounds for two months. Local lending
requirements on funding the escrow account vary.
{top}
- Income
tax rates
- The
Economic Growth and Tax Relief Reconciliation Act of 2001
cuts individual income tax rates for all brackets except
the 15% rate. A sixth tax bracket of 10% was also added
for the first $6,000 of income for single taxpayers,
$10,000 for single parents, and $12,000 for married
taxpayers. All rates except the 15% rate (and new 10%
rate) were cut by one-half percentage point on July 1,
2001. As a result, tax rates for all of 2001 are 10%, 15%,
27.5%, 30.5%, 35.5%, and 39.1%. For 2002, rates drop to
27%, 30%, 35%, and 38.6%. {top}
- Index
rate
- An
index rate is a widely used interest rate that lenders use
to set the interest rate on loans and credit cards. For
residential mortgages, 10-year U.S. Treasury securities
are often used for 30-year fixed-rate loans (on average,
most homeowners live in their homes for a period of time
closer to 10 years than 30 years). For ARM loans, a common
index is the Eleventh District Cost of Funds Index (COFI),
published by the San Francisco-based district office of
the Federal Home Loan Bank. For credit cards, the U.S.
commercial prime rate is frequently used as an index rate.
{top}
- Initial
interest rate
- The
starting interest rate on an adjustable-rate mortgage
loan, which is often below market ARM rates. The intent of
a low initial rate is to assist homebuyers that may not
otherwise qualify for a mortgage loan.
{top}
- Interest-only
payments
- Mortgage
payments that include only interest. No loan amortization
occurs and, thus, the homeowner does not accrue any equity
(unless the home value increases). {top}
- Interest
rate cap
- A
limit on the amount the interest rate can increase. A
periodic cap limits how much the rate can increase at each
adjustment period. A lifetime cap limits how much the rate
can increase during the term of the loan.
{top}
- Lifetime
cap
- A
lifetime cap is the limit to how much the interest rate on
an adjustable-rate loan can be increased over the term of
the loan. {top}
Loan-to-value
(LTV) ratio
- Homes:
Loan-to-value ratio is a key factor in determining how
much of a home you can qualify for. To calculate, divide
the mortgage loan amount by the fair market of the home
value. A recent appraisal is generally required to
determine fair market value. If you have existing mortgage
debt or are adding debt, divide the combined mortgage
balance by the home value. For example, a mortgage loan of
$150,000 on a home that is appraised at $200,000 has an
LTV of 75%. As a general rule, mortgage loans that exceed
an LTV of 80% require private mortgage insurance.
{top}
Loan
qualification estimates: aggressive versus conservative
- Lenders
ease their loan-underwriting guides when economic times
are good. This environment leads to more competition among
lenders for qualified borrowers. Thus, lenders become more
aggressive in making loans. When economic times are worse,
lenders rein the amounts they are willing to lend. Thus,
lenders become more conservative. {top}
- Margin
- Margin
has different meanings for different industries. For
mortgage lending, margin is the amount a lender adds to
the base rate of an adjustable-rate mortgage or other
variable-rate loan to set the loan rate. For example, if a
one-year ARM loan has a margin of 300 basis points over
the yield on 1-year Treasury bills and the T-bill yield is
6.5%, the loan rate is set to 9.5%. For brokerage
accounts, margin is the deposit required by an investor
who short-sells a stock (i.e., borrows shares from a
broker and sells the shares, hoping to buy them back at a
lower price and return the borrowed shares.)
{top}
- Mortgage
interest deduction
- The
mortgage interest tax deduction allows you to deduct the
mortgage interest expense you pay on mortgage and home
equity debt, up to certain limits of debt. The deduction
lowers your tax bill by an amount equal to the amount of
interest times your tax rate. To take the mortgage
interest deduction, you must itemize the deduction using
Schedule A of IRS Form 1040. {top}
- Mortgage
points
- Mortage
points are also called discount points, points, loan
discount points, loan origination fees or maximum loan
charges. A point is equal to 1 percent of the loan amount.
For example, 1 point on a loan of $150,000 equals $1,500.
Lenders consider mortgage points as interest that you pay
in advance. As a result, the more points you pay when you
close the loan, the lower your interest rate. If you
qualify, you may be able to deduct mortgage points in the
year you close the loan for tax purposes. Otherwise, you
will have to amortize the points paid over the term of the
loan. {top}
- Negative
amortization
- This
is a phenomenon in home lending which occurs when a
payment cap restricts the repayment to an amount less than
the payment necessary to reduce the principal balance.
This has the effect of increasing the loan amount.
{top}
- Origination
fee
- A
lender may charge an origination fee that is additional to
any mortgage points you pay. Origination fees are the
lender's charge for funding your mortgage with a mortgage
broker. The process of funding your loan is called
origination. {top}
- P+I
- P+I
is an acronym for loan principal and interest that you pay
on an amortizing loan, including mortgage loans. If your
mortgage loan payments include property taxes and
homeowner's insurance, the monthly payment amount is
referred to as P+I+T+I. {top}
- P+I+T+I
- P+I+T+I
is an acronym for loan principal, interest, property taxes
and homeowner's insurance. {top}
- Payment
cap
- A
limit on the amount that the monthly payment can increase.
A periodic cap limits the amount of the increase at each
adjustment period. A lifetime cap limits the amount that
the monthly payment can increase during the term of the
loan. A potential peril of payment caps is negative
amortization. In the case of an adjustable-rate mortgage
with a payment cap, rising interest rates may cause the
loan payment to be insufficient to cover even the interest
portion of the scheduled payment. In this case, the unpaid
interest may be added to the mortgage loan principal, if
the loan agreement permits. {top}
- Periodic
rate cap
- The
periodic interest rate cap is the maximum amount the loan
rate can change on an adjustable-rate mortgage loan on the
anniversary date. ARM loan rates are often reset once a
year after an initial period. A lifetime cap often exists.
A lifetime cap limits the maximum loan rate that can be
charged. {top}
- Prepayment
- A
prepayment is an amount that you pay on your mortgage or
other loan that constitutes an additional, unscheduled
payment. Prepayments pay off a loan sooner and reduce
total interest expense. {top}
- Prepayment
penalty
- A
prepayment penalty is a penalty that a lender may charge
if you make unscheduled, extra payments on your loan.
{top}
- Principal
- Principal
is either the original amount of your investment or loan.
In the case of an investment, principal is also called
your investment capital. In the case of a loan, principal
is also called the loan balance. {top}
- Prepaid
interest
- Prepaid
interest is the interest that you pay the lender in
advance, often when you close on a loan. If you close a
loan before the end of the month, the lender will require
you to pay interest for the number of days until the end
of the month. This is one form of prepaid interest.
Analyzers that calculate prepaid interest assume the loan
closing date is the midpoint of a 30-day month. As a
result, prepaid interest is calculated for 15 days. The
IRS recognizes points that you pay at loan closing as
prepaid interest. One point equals 1% of the loan amount.
If you meet a checklist of requirements, the IRS allows
you to deduct these points in the first year of your
mortgage loan. {top}
- Private
mortgage insurance (PMI)
- Private
mortgage insurance is an insurance policy that a
residential mortgage lender requires of the borrower if
the loan-to-value (LTV) ratio of the home is greater than
80%. Mortgage insurance protects the lender from the risk
that the borrower may default on the loan. Federal law
requires lenders to notify borrowers when the
loan-to-value ratio drops below 80%. Mortgage insurance
premiums vary, but generally range from $1,000 to $5,000 a
year for an average priced home. {top}
- Property
taxes
- Property
taxes are also called real estate taxes. These taxes are
paid to the local taxing authority or municipality. The
amount you pay can generally be deducted from your federal
income taxes. Property taxes are often levied as a
percentage of your home's assessed value. For example, if
you pay 0.5% in property taxes of the assessed value, a
home assessed at $250,000 would have a yearly property tax
bill of $1,250. {top}
- Refinancing
- Refinancing
is a means of replacing high-interest debt with a loan
that has a lower interest rate. But it can also be done in
order to switch from a fixed to variable rate, or vice
versa, or to eliminate a balloon payment. A cash-out
refinancing is one that involves you paying off your loan
and borrowing an additional amount. The entire loan amount
is secured by a mortgage lien on your home.
{top}
- Savings
interest rate
- The
savings interest rate is the yearly interest rate you earn
on your savings. It is also used to calculate the
opportunity cost of paying with cash. In contrast, the
saving rate is the percentage of income you save.
{top}
- Tax-deductible
- A
tax-deductible expense or contribution reduces your
taxable income. To calculate the worth of a tax deduction,
multiply the deduction by your income tax rate. For
example, if you deduct $10,000 in mortgage interest
expense and are in the 27% income-tax bracket, the tax
deduction is worth $2,700. If you deduct $1,000 in
contributions to a charity, the tax deduction is worth
$270. {top}
- Tax
savings
- Tax
savings are the amount you may save in taxes from a tax
deduction or credit that you would otherwise pay if you
did not have the deduction or credit. Tax savings are also
called a tax shield. To calculate tax savings from a
deduction, multiply the amount of the deduction by your
marginal income tax rate. At an income tax rate of 27%, a
$2,000 qualified contribution to a company retirement plan
may save you $560 in taxes. And if you paid $10,000 in
home mortgage interest, you may save up to $2,700 in
income taxes if you are in the same tax bracket. Your
deduction for interest expense on mortgage and home equity
debt may be limited. You may wish to consult a financial
or tax adviser. For businesses, tax savings are realized
on such deductible expenses as lease payments, interest on
loan payments, and depreciation expense. {top}
- Tax
shield
- Tax
shield is the amount of taxes you may save from a tax
deduction or tax credit that you would otherwise pay
without the deduction or credit. To calculate tax savings
from a deduction, multiply the amount of the deduction by
your marginal income tax rate. At a marginal income tax
rate of 27%, a $2,000 qualified contribution to a company
retirement plan may save you $560 in taxes. And if you
paid $10,000 in home mortgage interest, you may save up to
$2,700 in income taxes if you are in the same tax bracket.
Your deduction for interest expense on mortgage and home
equity debt may be limited. You may wish to consult a
financial or tax adviser. For businesses, tax savings are
realized on such deductible expenses as lease payments,
interest on loan payments, and depreciation expense.
{top}
- Term
- The
period of a loan, generally measured in years. Auto loans:
generally range between two and five years. Mortgage
loans: generally 15 or 30 years. {top}
- Treasury
bill
- U.S.
Treasury bills are short-term debt obligations of the U.S.
Treasury. T-bills are usually issued to mature in three or
six months. Prices for T-bills are stated as a discount to
the par value. For example, a T-bill with a price of 99.65
is selling for 99.65% of its par value. T-bills are
auctioned weekly and used to pay operations of the federal
government. T-bills are considered to be among the safest
and most liquid investments. {top}
- Underwriting
- Underwriting
means different things to different financial-services
industries. For mortgage lenders, it is the process of
evaluating a loan prospect to see if they have the
financial capacity to repay the loan. For investment
bankers, it is the process of arranging a sale of stocks
or bonds to investors. For insurance companies, it is the
process of calculating a premium for a specific pool of
insurees with certain risk characteristics such as age or
health. {top}
- Yield
- Yield
is used to measure the investment performance of a
security. For mutual funds, yield is generally measured as
dividends as a percentage of the price of a fund share.
For bonds, yield is often calculated in one or more of
three major ways: current yield, yield-to-maturity and
yield-to-call. Current yield is the bond coupon rate
divided by current price. It is an expedient but
incomplete method for calculating yield. Yield-to-maturity
(YTM) is the expected yield an investor earns for holding
a bond to maturity. YTM includes coupon income and any
premium or discount the investor pays. Yield-to-call is
the expected yield an investor earns if the bond is held
until its first call date, when it is assumed to be called
by the company that issued the bonds. Difference in bond
yields is called the yield spread or credit spread. Yield
spread measures the extra yield a bond must pay to
compensate for additional risk over a risk-free bond. For
example, if a 10-year corporate bond earns a yield of
6.25% and a 10-year U.S. Treasury bond yields 5.75%, the
yield spread is 50 basis points. {top}
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