Mortgage Loan FAQ

What is amortization?
Amortization is a fancy word for the schedule of loan payments. This schedule shows the principal and interest calculations over the term of the loan.

How are rates calculated?
Mortgage rates rise and fall along with securities found on Wall Street. Fixed rates are tied to the prime rate which is the rate that banks and lenders charge to their most credit worthy customers. Adjustable rates are usually tied to an index such as Treasury Securities, Certificates of Deposit or London Inter-Bank Offering Rate. As these rates fluctuate, so do the rates of ARM loans. Some ARMs adjust more frequently than others and oftentimes result in negative amortization meaning that interest that is not paid at the time is tacked on to the loan balance.

What are the parts of my payment?
The two basic parts of a mortgage are principal and interest. Principal is the amount of the payment that reduces the balance of the loan. Interest is the money the lender collects as a return on their investment. In most cases, the interest portion of the payment is larger than the principal portion at least in the early years of the loan.

What is an escrow account?
An escrow account is sometimes required by the lender. They require that you pay not only the principal and interest to them but additional mortgage related fees such as property taxes, insurance and homeowner association fees. The lender collects these monies from the borrower each month and places them into an escrow account. The escrow account then pays the tax collector, insurance company and homeowners associations on behalf of the borrower.

What is the difference between a fixed rate and an adjustable rate mortgage?
Interest rates on mortgages are either fixed or adjustable. A fixed rate mortgage charges the same interest rate for the duration of the loan. Adjustable interest rates fluctuate based on market conditions.

What is PMI?
A high loan to value ratio often kicks in a requirement for private mortgage insurance, or PMI. For instance, if a borrower can only make a down payment of 5% rather than the more typical 20% the lender will likely require PMI to lower the risks involved in making such a loan. PMI serves to protect the lender, not the borrower. PMI helps borrowers purchase a home with lower down payments but they will be charged a PMI premium each month as part of the house payment. As their home equity builds, they may be able to eventually remove the PMI requirement.

What are points?
A point is 1% of the loan amount and is either a factor in determining the interest rate or a loan fee. For example, on a $100,000 loan, one point equals $1000. Discount points are points paid upfront to reduce the interest rate. Discount points are tax deductible because they are considered pre-paid interest. The number of points varies from zero to three or four points depending on the interest rate. A no-points loan carries a higher interest rate than a loan with several discount points.

A second type of point is called an origination point. These are not tax deductible and don’t reduce the interest rate. Instead, the lender charges these to either boost profits or cover loan costs.

Why is my credit score important?
Lenders examine your creditworthiness before making the loan. Your credit score tells the lender how you have handled debt in the past. Borrowers with higher credit scores tend to get better interest rates than borrowers with lower scores because the risk to the lender is considered lower when the loan to borrowers with a good track record of paying their bills on time.

What are closing costs?
Closing costs are the fees that the borrower pays for refinancing or obtaining a new mortgage. These costs are presented upfront in the form of a good faith estimate. Common closing costs include points, appraisals, credit report, inspections, broker fees, document preparation and more. When buying a home, it is common to ask the seller to pay some or all of the closing costs.

What is a reverse mortgage?
The reverse mortgage is commonly used when a borrower is “house rich, cash poor”. That is to say, the borrower owns their home free and clear but needs income such as in retirement. The reverse mortgage allows the borrower to access the equity in their home and receive monthly payments from the lender. The mortgage is paid back after the home sells at a later date. Homeowners must be over 62 and occupy the house as their primary residence.

What is an interest-only mortgage?
Interest only loans never reduce the principal, the borrower pays only interest each month and the balance of the loan never falls.

What about property taxes?
If an escrow account is required, the property taxes will be added to the principal and interest and paid to the lender each month. If there is no escrow account, the borrower is responsible for paying their property taxes annually.

Why Do I Need Cash Reserves?
Cash reserves are often required by lenders to make sure the borrow is able to cover two to three months of living expenses in the event of a job loss or other emergency.

Do I need insurance?
Yes. Lenders require home owners insurance in order to protect their investment in your home.

What is a pre-payment penalty?
A pre-payment penalty is a fee that the borrower will pay the lender if he pays off the loan early.

What does it mean to lock in a rate?
Because interest rates fluctuate daily, it is advised to either lock in an interest rate or float an interest rate depending on the upward or downward trend. If interest rates are moving up, the borrower “locks” in the current rate. That way when the loan funds in the future, he will have the lower interest rate that he locked in. If rates are moving down, he might choose to “float” the rate for a shorter period and hope for a lower rate when the loan funds.