Many borrowers go through the closing process in a haze, nodding, smiling, and signing through a bunch of noise that sounds like Greek.
Even though you may have put your trust in your real estate and mortgage team, it helps to understand some of the terminology so that you can pay attention to specific details that may impact the decisions you need to make.
The term “docs sent” generally means you made it!! The lender’s closing department has sent the approved loan paperwork to the closing agent, which is usually an attorney or title company.
Keep in mind that there may be some prior to funding conditions the underwriter will need to verify before the deal can be considered fully approved.
2. Docs Signed –
Just what it implies. All documentation is signed, including the paperwork between the borrower and the lender which details the terms of the loan, and the contracts between the seller and buyer of the property.
This usually occurs at closing in the presence of the closing agent, bank representative, buyer and seller.
3. Funded –
Show me some money!
The actual funds are transferred from the lender to the closing agent, along with all applicable disclosures.
For a home purchase, if the closing occurs in the morning, the funds are generally sent the same day. If the closing occurs in the afternoon, the funds are usually transferred the next day.
The timing is different for refinancing transactions due to the right of rescission. This is the right (given automatically by law to the borrower) to back out of the transaction within three days of signing the loan documents. As a result, funds are not transferred until after the rescission period in a refinancing transaction, and are generally received on the fourth day after the paperwork is signed.
(Note – Saturdays are counted in the three day period, while Sundays are not). The right of rescission only applies to a property the borrower will live in, not investment properties.
4. Recorded –
Let’s make it official. The recording of the deed transfers title (legal ownership) of the property to the buyer. The title company or the attorney records the transaction in the county register where the property is located, usually immediately after closing.
There you have it – an official translation of closing lingo.
As with any other important financial transaction, there are many steps, some of which are dictated by law, which must be followed.
Timing the market for the best possible opportunity to lock a mortgage rate on a new loan is certainly a challenge, even for the professionals.
While there are several generic interest rate trend indicators online, the difference between what’s advertised and actually attainable can be influenced at any given moment by at least 50 different variables in the market, and with each individual loan approval scenario.
Outside of the borrower’s control, the mortgage rate marketplace is a dynamic, volatile, living and breathing animal.
Lenders set their rates every day based on the market activities of Mortgage Bonds, also known as Mortgage Backed Securities (MBS).
On volatile days, a lender might adjust their pricing anywhere from one to five times, depending on what’s taking place in the market.
Factors That Influence Mortgage Backed Securities:
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.
A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
As inflation increases, or as the expectation of future inflation increases, rates will push higher.
The contrary is also true; when inflation declines, rates decrease.
Famous economist Milton Friedman said “inflation is always and everywhere a monetary phenomenon.”
Public enemy #1 of all fixed income investments, inflation and the expectation of future inflation is a key indicator of how much investors will pay for mortgage bonds, and therefore how high or low current mortgage rates will be in the open market.
When an investor buys a bond, they receive a fixed percentage of the value of that bond as ‘coupon’ payments.
With MBS, an investor might buy a bond that pays 5%, which means for every $100 invested, they receive $5 in interest per year, usually divided up over 12 payments. For the buyer of a mortgage bond, that $5 coupon payment is worth more in the first year, because it can buy more today than it can in the future, due to inflation. When the markets read signals of increasing inflation, it tells bond investors that their future coupon payments will be less valuable by the time they receive them. So basically, this causes investors to demand higher rates for any new bonds they invest in.
As part of its 2008-2010 stimulus effort, the NY Fed spent almost all of its $1.25 trillion budget buying mortgage bonds. Many believe this strategy kept mortgage rates lower over a 15 month period.
The lending environment significantly changed between 2008, when the Fed began its mortgage bond purchasing program, and early 2010 when the market was left to survive on its own.
When the MBS purchase program was announced in November 2008, mortgage bonds reacted immediately and dramatically.
But at that time, there weren’t any investors willing to take a risk in buying mortgage bonds. The meltdown in the mortgage market and world economies lead many investors to shy away from the risks associated with MBS, which is why the Fed had to step in and basically assume the role as the sole investor of mortgage bonds.
However, loan underwriting guidelines drastically tightened up by 2010, which may create a little more confidence in the mortgage bond market.
3. Unemployment –
Decreasing unemployment will suggest that mortgage rates will rise.
Typically, higher unemployment levels tend to result in lower inflation, which makes bonds safer and permits higher bond prices. For example, the unemployment rate in March 2010 was at 9.7%, just slightly below its highest mark in the current economic cycle.
Every month, the BLS releases the Nonfarm Payrolls (aka The Jobs Report) which tallies the number of jobs created or lost in the preceding month.
The previous report indicated a loss of 36,000 jobs. Not necessarily a number that will move the needle on the unemployment gauge, but some economists suggest we need about 125,000 new jobs each month just to keep pace with population growth. So that negative 36,000 is more like negative 161,000 jobs short of an improving unemployment picture.
One flaw to pay attention to with unemployment rates is that the method of surveying fails to capture part-time workers who desire full-time employment, discouraged job seekers who have taken time off from searching and other would-be workers who are not considered to be part of the labor force.
4. GDP –
GDP, or Gross Domestic Product, is a measure of the economic output of the country.
High levels of GDP growth may signal increasing mortgage rates.
The Federal Reserve slashes short-term rates when GDP slows to encourage people and businesses to borrow money. When GDP gets too hot, there might be too much money floating around, and inflation usually picks up. So high GDP ratings warn the market that interest rates will rise to keep inflation concerns in balance.
Spiking GDP with flat/increasing unemployment begs some questions.
There are two major indicators that help provide more context:
1. Increases to worker productivity – employers are getting more work out of their current employees to avoid hiring new ones
2. Surges in inventory cycles – when the economy first started contracting, manufacturing slowed down to cut costs, and sales were made by liquidating inventory.
This is like a roller coaster cresting a hill, where one part of the train is going up, the other down. Eventually, the other side catches up, inventories are rebuilt by manufacturing more than is being sold. Both surges can throw off periodic reports of GDP.
5. Geopolitics –
Unforeseen events related to global conflict, political events, and natural disasters will tend to lower mortgage rates.
Anything that the markets didn’t see coming causes uncertainty and panic. And when markets panic, money generally moves to stable investments (bonds), which brings rates lower. Mortgage bonds pick up some of that momentum.
Acts of terrorism, tsunamis, earthquakes, and recent sovereign debt crises (Dubai, Greece) are all examples.
Putting It All Together:
Economic data is reported daily, and some items have a greater tendency to be of concern to the market for mortgage rates. If you are involved in a real estate financing transaction, it’s helpful to be aware of these influences, or to rely upon the advice of a mortgage professional who is already dialed in.
When shopping for a new mortgage loan, you may notice an Annual Percentage Rate (APR) advertised next to the note rate. The inclusion of an APR is actually mandated by federal law in order to help give borrowers a standard rule of measurement for comparing the total cost of each loan.
The APR is designed to represent the “true cost of a loan” to the borrower, expressed in the form of a yearly rate to prevent lenders from “hiding” fees and up-front costs behind low advertised rates.
The terms annual percentage of rate (APR) and nominal APR describe the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mortgage, credit card, etc. It is a finance charge expressed as an annual rate.
The nominal APR is the simple-interest rate (for a year).
The nominal APR is calculated as: the rate, for a payment period, multiplied by the number of payment periods in a year.
However, the exact legal definition of “effective APR” can vary greatly, depending on the type of fees included, such as participation fees, loan origination fees, monthly service charges, or late fees.
The effective APR has been called the “mathematically-true” interest rate for each year.The computation for the effective APR, as the fee+compound interest rate, can also vary depending on whether the up-front fees, such as origination or participation fees, are added to the entire amount, or treated as a short-term loan due in the first payment.
What Fees Are Typically Included In APR?
Buydown funds from the buyer
Prepaid Mortgage Interest
Mortgage Insurance Premiums
Other lender fees (application, underwriting, tax service, etc.)
Since origination fees, discount points, mortgage insurance premiums, prepaid interest and other items may also be required to obtain a mortgage, they need to be included when calculating the APR. Fees such as title insurance, appraisal and credit are not included in calculating the APR.
The APR can vary between lenders and programs due to the fact that the federal law does not clearly define specifically what goes into the calculation.
What Does APR Not Disclose?
APR on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But Adjustable Rate Mortgages always change over the course of 30 years.
Length of Rate Lock
Comparison between loan terms – EX: A 15-year term will have a higher APR simply because the fees are amortized over a shorter period of time compared to a similar rate / cost scenario on a 30-year term.
APR Comparing Examples:
Bank (A) is offering a 30 year fixed mortgage at 8.00% APR
Bank (B) is offering a 30 year fixed mortgage at 7.00% Note Rate
Easy choice, right?
While Bank (B) is advertising the lowest Note Rate, they’re not factoring in the origination points, underwriting / processing fees and prepaid mortgage interest (first month’s mortgage payment), which could essentially make the APR much higher than the one Bank (A) is advertising. So Bank (A) may show a higher rate due to the APR, but they could actually be charging a lot less in total fees than Bank (B).
Before lenders and mortgage brokers were required to state the APR, it was more difficult to find the truth about the total borrowing costs of one loan vs another. When comparing mortgage rates, it’s a good idea to ask your lender which fees are included in their APR quote.
Many people believe that interest rates are simply set by lenders, but the reality is that mortgage rates are largely determined by what is known as the Secondary Market.
The secondary market is comprised of investors who buy the loans made by banks, brokers, lenders, etc. and then either hold them for their earnings, or bundle them and sell them to other investors. When the secondary market sells the bundles of mortgages, there are end investors who are willing to pay a certain price for those loans.That market price of those Mortgage Backed Securities (MBS) is what impacts mortgage rates.
Typically, investors are willing to accept a lower return on mortgage backed securities because of their relative safety compared to other investments.
This perception of safety is due to the implied government backing of Fannie Mae and Freddie Mac and the fact that the Mortgage Backed investments are based on real estate collateral. So, if the loan defaults there is real property pledged against potential losses.
In contrast, other investments are considered more risky, specifically stocks which are based on earnings and profit vs real property. The movement between the two investment vehicles often dictates mortgage rates.
Why Do Mortgage Rates Change?
Mortgage rates fluctuate based on the market’s perception of the economy.
Stocks are considered riskier investments, and therefore have an expected higher rate of return to compensate for that risk. When the economy is thriving, it is presumed that companies will perform better, and therefore their stock prices will move higher. When stock prices move higher – MBS prices generally move lower. Mortgage Backed Securities, however, thrive when the economy is perceived as not doing well. When investors forecast a faltering economy, they worry that the return on stocks will be lower, so they frequently engage in a ‘flight to safety’ and buy more secure investments such as Mortgage Backed Securities. Mortgage rates are actually based on the yield of those Mortgage Backed Securities.
Bonds are sold at a particular price based on their value in relation to other available investments. When a bond is sold it yields a certain return based on that original purchase price. As the prices of the MBS increases because investors seek their safety, the yield decreases. Conversely, when investors seek the higher returns of stocks and the MBS are purchased in lesser quantities the price goes down. The lower price results in a higher yield, and this yield is what determines mortgage rates.
How Would I Know if Rates are Expected to Go Up or Down?
When the economy is growing or is expected to grow, stocks will likely become the more favored investment.
When investors buy more stocks, they purchase fewer MBS, which drives the price down.
When the price of the MBS is lower, the yield increases.
Since mortgage rates are based on the yield of the 30 Year MBS, you would expect rates to increase in this environment.
When the economy appears to be slowing or is doing poorly, investors typically move their money out of the stock market and into the safety of the MBS.
This drives the price of these investments higher, which results in a lower yield.
Since mortgage rates are based on the yield of the 30 Year MBS, you would expect rates to decrease in this environment.
Since these market variables and expectations change multiple times as economic reports are released throughout the course of a week, it is not uncommon to see mortgage rates change several times a day.
Understanding how rates move is not necessarily as important as having a loan officer that is equipped with the technology and professional services to track and stay alerted at the precise moment rates make a move for the better or worse.
DTI is a component of the mortgage approval process that measures a borrower’s Gross Monthly Income compared to their credit payments and other monthly liabilities.
Debt-to-Income Ratios are designed to give guidance on acceptable levels of debt allowed by particular lenders or programs.
There are actually two different Debt-to-Income Ratios that underwriters will review in order to determine if a borrower’s monthly income is sufficient to cover the responsibility of a mortgage according to the particular lender / mortgage program guidelines.
Most loan programs allow for a Total DTI of 43% and a Housing DTI of 31%.
Two Types of DTI Ratios:
a) Front End or Housing Ratio:
Should be 28-31% of your gross income
Divide the estimated monthly mortgage payment by the gross monthly income
b) Back End or Total Debt Ratio:
Should be less than 43% of your gross monthly income
Divide the estimated house payment plus all consumer debt by the gross monthly income
Remember, the DTI Ratios are based on gross income before taxes. Lenders also prefer to use W2’s or tax returns to verify income and employment.
However, the adjusted gross income is used to calculate DTI for self-employed borrowers on most loan programs. Since there is room for interpretation on these guidelines, it’s important to review your personal income / employment scenario in detail with your trusted mortgage professional to make sure everything fits within the guidelines.
Understanding the definition of Loan-to-Value (LTV), and how it impacts a mortgage approval, will help you determine what type of loan amount and program you may qualify for.
Since the LTV Ratio is a major component of getting approved for a new mortgage, it’s a good idea to learn the simple math of calculating the amount of equity you may need, or down payment to budget for in order to qualify for a particular loan program.
In addition to determining what mortgage programs are available, LTV also is a key factor in the amount of mortgage insurance required to protect the lender from default.
On a conventional loan, mortgage insurance is usually required if you have an LTV over 80% (one loan is more than 80% of the home’s appraised value). On that point, if you are currently paying mortgage insurance and think that your LTV is less than 80%, then it may be time to refinance, or call your lender to restructure the payment.
Frequently Asked LTV Questions:
Q: Why do the lenders care about Loan to Value?
Lenders care about the LTV because it helps determine the exposure and risk they have in lending on a certain property. Statistics show that borrowers with a lower LTV are less likely to default on their mortgage. Also, with a lower LTV the lender will lose less money in case of a foreclosure.
Q: Can I drop my mortgage insurance on an FHA loan?
The mortgage insurance on an FHA loan is structured differently than a conventional loan. On a 30 year fixed FHA loan, the monthly mortgage insurance can be removed after five years, as well as when the borrower’s loan is 78% LTV.
Q: What does CLTV stand for?
CLTV stands for Combined Loan To Value. The CLTV calculation is as follows:
(1st Mortgage Amount + 2nd mortgage amount) / Appraised Value of Property = CLTV
While most mortgage web sites offer a glossary containing hundreds of real estate and lending related terms, we wanted to highlight the top terms that most borrowers will hear several times throughout the approval and home buying process.
Understanding the “Shop Talk” between the various industry professionals that you’ve assembled on your team will hopefully give you greater confidence when discussing important topics that may impact your transaction.
Mortgage Related Terms:
A schedule of payments showing the amount applied to the principal and interest through the payoff.
Annual Percentage Rate (APR):
The effective rate of interest that includes loan related fees. The APR helps determine the total cost of borrowing a loan and is used to compare loans that are advertised with different note rates.
Adjustable Rate Mortgage (ARM):
As opposed to a fixed-rate mortgage where the payment is set for the full term of the loan agreement, an ARM is tied to a specific financial index and may adjust after a set amount of time.
Where a borrower pays an up-front fee to lower the mortgage rate and monthly payment. Rate Buydowns can be used to help a borrower qualify for a loan, or as a means of negotiation where the seller would contribute to a lower rate in order to entice a buyer to purchase their property.
Combined Loan-to-Value (CLTV):
The total amount of mortgage obligations on a particular property compared to the fair market value.
Debt-to-Income Ratio (DTI):
A borrower’s minimum monthly liability payments divided by their gross monthly income.
Failure to fulfill an obligation to pay a mortgage.
Late payments on a monthly liability. Creditors generally report payments to credit bureaus once the delinquency goes past 30 days.
A big stack of documents that the lender, buyer and sellers sign during a real estate purchase or mortgage transaction. These disclosures may also notify all parties involved of their rights and obligations.
Each individual actually has three credit scores at any given time for any given scoring model because the three credit agencies have their own databases, gather reports from different creditors, and receive information from creditors at different times.
A good faith estimate must be provided by a mortgage lender or broker in the United States to a customer, as required by the Real Estate Settlement Procedures Act (RESPA). The estimate must include an itemized list of fees and costs associated with your loan and must be provided within three business days of applying for a loan.
These mortgage fees, also called settlement costs or closing costs, cover every expense associated with a home loan, including inspections, title insurance, taxes and other charges.
A good faith estimate is a standard form which is intended to be used to compare different offers (or quotes) from different lenders or brokers.
Total taxable income which is generally verified by a lender through tax returns and W2’s.
Home Equity Line of Credit (HELOC):
A line of credit secured by real estate.
A comprehensive and itemized list of closing costs prepared by a closing agent that details all of the financial figures in a mortgage refinance or purchase transaction.
When more than one person applies for and secures a mortgage.
Fannie Mae (FNMA) and Freddie Mac (FHLMC) are large agencies that purchase the bulk of U.S. residential mortgages from banks and other lenders, allowing them to free up liquidity to lend more mortgages.
When FNMA and FHLMC limits don’t cover the full loan amount, the loan is referred to as a “jumbo mortgage”. The average interest rates on jumbo mortgages are typically higher than that of conforming mortgages.
The loan-to-value (LTV) ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower wants $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87% (LTV).
Loan to value is one of the key risk factors that lenders assess when qualifying borrowers for a mortgage. The risk of default is always at the forefront of lending decisions, and the likelihood of a lender absorbing a loss in the foreclosure process increases as the amount of equity decreases. Therefore, as the LTV ratio of a loan increases, the qualification guidelines for certain mortgage programs become much stricter. Lenders can require borrowers of high LTV loans to buy mortgage insurance to protect the lender from the buyer default, which increases the costs of the mortgage.
The valuation of a property is typically determined by an appraiser, but there is no greater measure of the actual real value of one property than an arms-length transaction between a willing buyer and a willing seller. Typically, banks will utilize the lesser of the appraised value and purchase price if the purchase is “recent.” What constitutes recent varies by institution but is generally between 1–2 years.
Loan Rate Lock:
Where the loan officer locks a specific rate with a lender for a set amount of time.
Money in a bank or investment account that can be obtained quickly.
Loan Origination Fee:
A fee paid by a borrower to a lender for obtaining a mortgage loan.
A mortgage servicer is the company that borrowers pay their mortgage loan payments to. Mortgage servicers either purchase or retain mortgage servicing rights that allow them to collect payments from borrowers in return for a servicing fee. The duty of a mortgage servicer varies, but typically includes the acceptance and recording of mortgage payments; calculating variable interest rates on adjustable rate loans; payment of taxes and insurance from borrower escrow accounts; negotiations of workouts and modifications of mortgage upon default; and conducting or supervising the foreclosure process when necessary.
Many borrowers confuse mortgage servicers with their lender. A mortgage servicer may be a borrower’s lender, but often the beneficial rights to the payment of principal and interest on mortgages are sold to investors such as Fannie Mae, Freddie Mac, Ginnie Mae, FHA, and private investors in mortgage securitization transactions.
Mortgage insurance (also known as mortgage guaranty) is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. Mortgage insurance can be either public or private depending upon the insurer.
Mortgage Backed Security:
A mortgage-backed security (MBS) is an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans, most commonly on residential property.
First, mortgage loans are purchased from banks, mortgage companies, and other originators. Then, these loans are assembled into pools. This is done by government agencies, government-sponsored enterprises, and private entities, which may offer features to mitigate the risk of default associated with these mortgages.
Mortgage-backed securities represent claims on the principal and payments on the loans in the pool, through a process known as Securitization. These securities are usually sold as bonds, but financial innovation has created a variety of securities that derive their ultimate value from mortgage pools.
Private Mortgage Insurance (PMI):
Private mortgage insurance (PMI) is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan. It is insurance to offset losses in the case where a borrower is not able to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property.
Real Estate Related Terms
Generally used when a seller accepts the terms presented in a purchase contract offer.
A “Subject To” provision in a purchase contract or mortgage approval that requires more work or documents to be submitted prior to a final decision to be completed.
The period of time described in a purchase contract for the buyer and seller to perform certain duties such as appraisal, loan approval and inspections.
In real estate, a trust deed or deed of trust, is a document wherein specific financial interest in the title to real property is transferred to a trustee, which holds it as security for a loan (debt) between two other parties.
One is referred to as the trustor the other referred to as the beneficiary. In its simplest terms the trustor would be the receiver of money and the beneficiary would be the lender of money. The trust deed document most likely would be recorded (constructive notice) with the County Recorder where the property is located as evidence of and security for the debt.
When the loan is fully paid, the monetary claim on the title is transferred to the borrower by reconveyance to release the debt obligation. If the borrower defaults on the loan, the trustee has the right to foreclose on and transfer title to the lender or sell the property to pay the lender from the proceeds.
The deposit money deposited in escrow by a buyer in good faith to secure a purchase transaction.
A third party that holds money or property in trust until a transaction has been complete. There are several uses for the word “Escrow” in the real estate or mortgage process. Closing Escrow describes when a purchase transaction is complete. An Escrow or Impound account involves having your annual property and hazard insurance payments handled by a third party and taken out of monthly installments in a mortgage payment.
The difference between a loan balance and a property’s fair market value.