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A Beginners Guide To Mortgage Lending & Loan Terms

The housing market is in a bit of a state as I am sure you know. The sub-prime mortgage crisis in the US has triggered a global slowdown in the housing economies around the world. Foreclosures have risen and many people are finding it hard to make payments. In the UK it led to a run on the Northern Rock Bank which eventually had to be bailed out by the Bank of England.

In light of these new instruments and as a simple guide to help first time borrowers we thought it would be a good idea to run through some of the more common terms used by mortgage lenders so that these unfamiliar terms could be understood in plain English.

Adjustable rate mortgage (ARM)

A mortgage in which the interest rate is NOT fixed but is tied to an index such as the Federal Reserve Base Lending Rate and is periodically adjusted as the rate index moves up and down. Also known as Variable Rate Mortgages, this type of loan means that your payments can rise and fall depending on prevailing interest rates The initial rate is lower than the fixed rate mortgage. Such ARMs commonly provide for an option to convert to a fixed rate mortgage.

Sub-Prime rate mortgage

These are the mortgages that you have seen in the news recently and are most common in the US. In the UK they are called discount variable rate mortgages. The initial payments are set at a discount to the actual interest rate due for a set period of time, a year or two years. After the initial period, payments are adjusted to take into account the prevailing rates at the time. These mortgages were linked to sub-prime credit borrowers and the resulting interest rate charged was at a premium. This led to some low income families being unable to make the payments when interest rates rose and the deferred payment period expired.

Annual percentage rate (APR)

The actual cost of borrowing money. It is expressed in the form of an annual rate to make it easier to compare the cost of borrowing money among several lenders. The APR includes all the financing costs of a mortgage, including points, origination fees and other finance charges and the mortgage interest. This is the true rate of borrowing and is a rate to look out for. Where an advertisement may say 5%(7.2%APR) then you can differentiate between the rate that your monthly payments are based on and the charges involved in setting up the mortgage. The APR is a good method to compare mortgages where a discount rate may apply for an initial period.
Interest-Only Mortgage/ Balloon Payment Mortgage

This type of mortgage requires payments of only the interest portion of the loan, (interest-only) leaving the capital at its original value. With balloon payment mortgages you are required to make a final payment of a much larger capital sum than your usual monthly payments. In this case the monthly payments are lower because you have not been paying off enough of the capital to totally repay the loan over the term of the mortgage.

Fixed rate Mortgage

The most common type of mortgage. Your interest rate and payments are fixed for the term of the mortgage. Especially good when interest rates are low as you are able to lock in your payments at the low rate for the term of the loan.
These are some of the most common terms and phrases used in the mortgage industry today. When choosing a mortgage provider it is always important that you understand all the terms and conditions of the contract you are entering into.

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