A mortgage that does not have a fixed interest rate. The rate changes during the life of the loan in line with movements in an index rate, such as the rate for Treasury securities or the Cost of Funds Index. Federal Reserve Board
A type of loan between subprime and prime. Typically has a high loan-to-value ratio, which makes it riskier than traditional loans but are often made to prime-caliber borrowers. Consumer Federation of America
Monthly payments are large enough to pay the interest and reduce the principal on your mortgage. Federal Reserve Board
The cost of credit expressed as a yearly rate. The APR includes the interest rate, points, broker fees, and certain other credit charges that the borrower is required to pay. Federal Reserve Board
Many lenders will present a form called an arbitration agreement. You agree to going to a neutral, independent arbitrator if you are harmed by the lender and you could end up waiving your rights to a jury trial. Civil Justice
A loan structure that allows you to pay a set rate for a period of time that escalates into a huge payment. Many borrowers are unaware they have a balloon in their note. Center for Responsible Lending
A limit on the amount your interest rate can increase. Interest caps come in two versions. Periodic caps limit the interest-rate increase from one adjustment period to the next. Overall caps limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have an overall cap. Federal Reserve Board
A limit on how much the monthly payment may change, either each time the payment changes or during the life of the mortgage. Payment caps do not limit the amount of interest the lender is earning, so they may lead to negative amortization. Federal Reserve Board
Mortgage loans other than those insured or guaranteed by a government agency such as the FHA (Federal Housing Administration), the VA (Veterans Administration), or the Rural Development Services (formerly know as Farmers Home Administration, or FmHA). Federal Reserve Board
The difference between the fair market value of the home and the outstanding mortgage balance. Federal Reserve Board
During the first few years of a traditional mortgage loan, most of your monthly payment goes to interest. The rest goes toward the principal, so that you start to build equity in your home through payments. Thus, the amount you owe declines and you own more of your home. If you make interest-only payments, you are not building equity. And if you make only the minimum payments with a payment-option ARM, you may actually be adding to the amount you owe (and decreasing your equity) because unpaid interest is added to the loan's principal. Federal Reserve Board
The holding of money or documents by a neutral third party prior to closing. It can also be an account held by the lender (or servicer) into which a homeowner pays money for taxes and insurance. Federal Reserve Board
Mortgages that have an interest-only, payment-option, piggy-back or minimum payment features. Consumer Federation of America
Generally these loans have repayment terms of 15, 20, or 30 years. Both the interest rate and the monthly payments (for principal and interest) stay the same during the life of the loan. Federal Reserve Board
The Real Estate Settlement Procedures Act (RESPA) requires your mortgage lender to give you a good faith estimate of all your closing costs within 3 business days of submitting your application for a loan, whether you are purchasing or refinancing a home. The actual expenses at closing may be somewhat different from the good faith estimate. Federal Reserve Board
The index is the measure of interest-rate changes that the lender uses to decide how much the interest rate on an ARM will change over time. No one can be sure when an index rate will go up or down. Some index rates tend to be higher than others, and some change more often. You should ask your lender how the index for any ARM you are considering has changed in recent years, and where the index is reported. Federal Reserve Board
The price paid for borrowing money, usually given in percentages and as an annual rate. Federal Reserve Board
Allows you to pay only the interest for a specified number of years. After that, you must repay both the principal and the interest. Most mortgages that offer an interest-only payment plan have adjustable interest rates, which means that the interest rate and monthly payment will change over the term of the loan. The changes may be as often as once a month or as seldom as every 3 to 5 years, depending on the terms of your loan. For example, a 5/1 ARM has a fixed interest rate for the first 5 years; after that, the rate can change once a year (the "1" in 5/1) during the rest of the loan. The interest-only payment period is typically between 3 and 10 years. After that, your monthly payment will increase, even if interest rates stay the same, because you must pay back the principal as well as the interest. For example, if you take out a 30-year mortgage loan with a 5-year interest-only payment period, you can pay only interest for 5 years and then both principal and interest over the next 25 years. Because you begin to pay back the principal, your payments increase after year 5. Federal Reserve Board
Most payment-option ARMs have interest rates that adjust monthly after the introductory period. You could find that the interest you owe increases even though your minimum payment stays the same each month, adding to your negative amortization. Typical interest rate adjustment periods for an interest-only mortgage are monthly, every 6 months, or once a year. Federal Reserve Board
Many option ARMs have a 1-month or 3-month introductory period at the beginning of the loan. During this period, lenders use a lower interest rate to calculate your payments. For some interest-only mortgage payment loans, this introductory period lasts 1, 3, or 5 years. Federal Reserve Board
Fees charged by the lender for processing the loan and are often expressed as a percentage of the loan amount. Federal Reserve Board
Refers to a written agreement guaranteeing a home buyer a specific interest rate on a home loan provided that the loan is closed within a certain period of time, such as 60 or 90 days. Often the agreement also specifies the number of points to be paid at closing. Federal Reserve Board
A lender will charge a higher interest rate because borrowers do not have to provide as much or any documentation about their income. Consumer Federation of America
The number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment. Federal Reserve Board
A document signed by a borrower when a home loan is made that gives the lender a right to take possession of the property if the borrower fails to pay off the loan. Federal Reserve Board
Occurs when the monthly payments do not cover all the interest owed. The interest that is not paid in the monthly payment is added to the loan balance. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Federal Reserve Board
Mortgages that have an interest-only, payment-option, piggy-back or minimum payment features. Consumer Federation of America
The difference between the lowest available price and any higher price that the home buyer agrees to pay for the loan. Loan officers and brokers are often allowed to keep some or all of this difference as extra compensation. Federal Reserve Board
Most interest-only mortgages and payment-option ARMs have payments that adjust once a year. In addition, most of the adjustments on payment-option ARMs are limited by a payment cap, usually 7.5%. Keep in mind that payment caps do not apply when your loan is recalculated at the normal recalculation period. Payment caps also do not apply if your balance grows beyond 110% or 125% of your original mortgage amount. Federal Reserve Board
A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. The options typically include three choices. (1) A traditional payment of principal and interest, which reduces the amount you owe on your mortgage, where payments may be based on a set loan term like a 15, 20 or 40 year payment schedule. (2) An interest-only payment, which does not change the amount you owe on your mortgage. (3) A minimum or limited payment, which may be less than the amount of the interest due that month and may not pay down any principal, which means if you chose this option, the amount of interest you do not pay will be added to the principal of the loan, increasing the amount you owe and increasing the interest you pay. Federal Reserve Board
When your payments go up a lot, as much as double or triple, after the interest-only period or when the payments adjust. Federal Reserve Board
The loan enables borrowers to make a minimum-payment which is less than what the amortization would be required to pay down the interest and a portion of the interest of the loan. Similar to a credit card, you loan size could increase instead of decrease, putting borrowers into payment shock when the increasing loan sizes reach a ceiling and result in higher payments. Consumer Federation of America
Technically called a simultaneous second mortgage, this loan is used by borrowers wishing to avoid paying private mortgage insurance. Instead of paying a premium by purchasing insurance, a lender will provide another mortgage for the down payment. Some consumers will borrow up to 100% of the loan as a result, which can cause higher payments and little equity if a homeowner wants to refinance. Consumer Federation of America
Fees paid to the lender for the loan. One point equals 1 percent of the loan amount. Points are usually paid in cash at closing. In some cases, the money needed to pay points can be borrowed, but doing so will increase the loan amount and the total costs. Federal Reserve Board
Extra fees that may be due if you pay off the loan early by refinancing your home. These fees may make it too expensive to get out of the loan. If your loan includes a prepayment penalty, be aware of the penalty you would have to pay. Ask the lender if you can get a loan without a prepayment penalty, and what that loan would cost. Federal Reserve Board
The amount of money borrowed or the amount still owed on a loan. Federal Reserve Board
Protects the lender against a loss if a borrower defaults on the loan. It is usually required for loans in which the down payment is less than 20 percent of the sales price or, in a refinancing, when the amount financed is greater than 80 percent of the appraised value. Federal Reserve Board
With a payment-option ARM, your loan will be recalculated, or recast. The recalculation period is usually 5 years, but it can vary depending on the terms of your loan. When your loan is recalculated, the 7.5% payment cap does not apply, so you could see a large change in your monthly payment. After your loan is recalculated, you will still have the option to make a minimum payment. Interest-only loans are recalculated at the end of the option period (usually 3, 5, or 10 years); after that you will pay back both the principal and interest for the remaining term of the loan. Federal Reserve Board
Loans that are more expensive than traditional mortgages because the interest rates are highter than a traditional loan. They are typically given to borrowers with a credit score of 620 or less. Center for Responsible Lending
Prime or near-prime loans have interest rates that are below 3 percentage points for first lien loans, or below 5 percentage points for all subordinate loans, of the comparable Treasury yield threshold, which compares mortgages to comparable Treasury long-term securities. Higher-priced subprime loans have interest rates 3 points or more above the threshold for first-lien loans, 5 points or more for all subordinate liens. Federal Reserve Board
A general term for savings banks and savings and loan associations. Federal Reserve Board
May include application fees; title examination, abstract of title, title insurance, and property survey fees; fees for preparing deeds, mortgages, and settlement documents; attorneys fees; recording fees; and notary, appraisal, and credit report fees. Under the Real Estate Settlement Procedures Act, the borrower receives a good faith estimate of closing costs at the time of application or within three days of application. The good faith estimate lists each expected cost either as an amount or a range. Federal Reserve Board
A general term for savings banks and savings and loan associations. Federal Reserve Board
SOME OF THE MORE COMMON LOANS YOU WILL RUN INTO:
If you borrow $180,000, the monthly payment stays at $1,161 over the life of the loan. Federal Reserve Board
If you borrow $180,000, the monthly payment stays at $1,126 for 5 years but then changes with the interest rate. In the example, the monthly payment would be $1,344 if interest rates rose 2% in year 6. A 5/1 ARM is an ARM in which the rate is fixed for the first 5 years and then may adjust every year during the remainder of the loan term. Federal Reserve Board
If you borrow $180,000, the monthly payment stays at $1,035 for the first 5 years and then increases to $1,261 in year 6 as you begin to pay down the principal. Federal Reserve Board
If you borrow $180,000, the monthly payment stays at $960 for 5 years but increases to $1,204 in year 6. The payment rises because interest rates are rising and because you did not pay down the principal during the first 5 years. If interest rates rose 2%, the monthly payment in year 6 would be $1,437. Federal Reserve Board
If you borrow $180,000, the minimum monthly payment starts at $630, but this amount does not cover all of the interest ($957). The payment rises 7.5% each year (payments are $677 in year 2, $728 in year 3, $783 in year 4, and $842 in year 5). The loan is recast at the beginning of year 6. If interest rates stay the same, the monthly payment would be $1,308. If interest rates go up 2%, the monthly payment would be $1,562. Federal Reserve Board
A predatory loan. Makes up 70% of the subprime market. The loan has a very low teaser interest rate for the first two year and then jumps exponentially, often 30-50% more. Sometimes called an exploding ARM. Center for Responsible Lending