Bonus – Mortgage Terms and Explanations
If you’re here because your “so called” loan officer is launching abbreviated mortgage terms and acronyms at you like dodge balls, my initial impulse is to toss out a red flag.
Red flags mean WARNING!
In the sales profession, it is not uncommon for inexperienced sales people to use insider, or industry talk to try to sound smarter than you, as a tactic for earning your business, by sounding “like they knew what they were talking about”.
In my opinion, a good loan officer should be more of a trusted guide. Your experience buying a home is about your personal goals, wants and needs, not “how smart” the loan officer sounds.
What I am trying to say is that our goal is to guide you through the process in a way that you constantly and confidently feel that you can cross the finish line in a sane and timely manner.
A professional loan officer will educate and empower you to make more informed decisions throughout the home buying process.
An unprofessional loan officer will bury you in industry jargon and acronyms and hope that you don’t ask too many hard questions…..Quit trying to show off!
Mortgage Terms and Acronyms
I’m not going to bury you in every mortgage term under the sun, there are plenty of places on the internet to get those crazy lists. But the truth is, most of those terms don’t apply to your situation. So, how do you know which ones do?
I am going to hit on the most common terms that apply to all home loan transactions. This list will be updated as forms, or terms change. I will always update the date so you know it’s current.
In most cases, this list will be reviewed annually for accuracy, unless there is a known change in disclosures, or standard forms. We already know that there is a new loan application (see 1003) with a whole new look and feel scheduled to be released in January 2018.
NOTE: If there is a commonly used acronym or abbreviation for a term, it will be listed in alphabetical order listing the abbreviation or acronym first.
1003 – aka Loan Application
Pronounced “ten-oh-three”, this is a standard Fannie Mae designed Residential Loan Application that has been the norm for decades. A new application has been developed, and will be mandatory in January, 2018. The new application is a called a URLA, or Uniform Residential Loan Application.
When you buy or refinance your home, the bank is going to order an appraisal, to determine the current value of the home. The reality is, they want to know how much they could sell it for in the event that a default happens.
AUS – Automated Underwriting System
A generic term for an automated risk assessment program like Fannie Mae’s Desktop Underwriter (DU), or Freddie Mac’s Loan Program Advisor (formerly Loan Prospector – LP). FHA and VA loan use Fannie Mae’s DU.
An AUS will analyze income, assets, employment, credit, and many other compensating factors to produce an instant, conditional underwriting approval.
The reason that all AUS findings are conditional is because it is based solely on what you, or the loan officer inputs into the application. It is very easy to either purposely, or accidentally put inaccurate, unverified, or ineligible information on an application and get a false approval because it is based on bad information.
You will find that most sellers will not accept an offer to buy their home if you do not have AUS findings from your lender saying that you’re eligible for financing.
Additional Reading: How Do Automated Underwriting Decisions Work?
CD – Closing Disclosure
A Closing Disclosure is a five-page form that provides final details about the mortgage loan you have selected. Your CD includes the loan terms, your projected monthly payments, and how much you will pay in fees and other costs to get your mortgage (closing costs).
The Closing Disclosure is a new form. For most kinds of mortgages, borrowers who apply for a loan on or after October 3, 2015 will receive a Closing Disclosure.
The lender is required to give you the Closing Disclosure at least three business days before you close on the mortgage loan.
This three-day window allows you time to compare your final terms and costs to those estimated in the Loan Estimate that you previously received from the lender. The three days also gives you time to ask your lender any questions before you go to the closing table.
Additional Reading: Closing Disclosure form with interactive tips and definitions.
A compensating factor will come into play if your loan needs to be manually underwritten, or a speciality loan like Jumbo financing, or an alternative documentation loan.
Essentially compensating factors are automatically assessed by the Automated Underwriting System (AUS),
DTI – Debt to Income Ratio
Your debt to income ratio is the qualifying factor that determines how much you can borrow. Not all loans have the same debt to income requirements. The most commonly published, and most defined debt to income ratios are with Conventional, and FHA financing.
A debt to income ratio represents the percentage of your gross monthly income (before taxes), that will be allowed for your housing and the payments for your liabilities as reported on your credit report.
Conventional, Fannie Mae or Freddie Mac, is looking at a maximum back end DTI of 45%. This means that your total housing expense, including principal, interest, taxes, insurance, and mello-roos, HOA, or mortgage insurance if applicable, plus all of your liabilities from your credit report cannot exceed 45% of your Qualifying Income.
If you have high FICO scores, 20% or more equity (or downpayment), and reserves, these are called compensating factors. With compensating factors, Conventional financing may allow up to 50% debt to income ratio.
FHA insured financing uses two different debt to income ratios. The “front end” and the “back end” ratios. A “front end” ratio is your total projected housing expense including a fully amortized principal and interest payment, including hazard insurance, property taxes, mortgage insurance, and Mello-Roos or HOA fees if applicable.
FHA guidelines allow the mortgage payment to be as high as 46.99% of your *qualifying income, and when you add all of your liabilities from your credit report, FHA will allow your back end DTI to go up to 56.99% of your Qualifying Income.
DU – Desktop Underwriter
Fannie Mae is the mother of home loan risk assessment and decisioning automation. Desktop Underwriter was the first automated underwriting program that will analyze income, assets, employment, credit, and many other compensating factors to produce an instant, conditional underwriting approval.
Desktop Underwriter is used to underwrite Fannie Mae conventional loans, as well as FHA and VA loans.
Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.
That’s the “standard” definition of an extenuating circumstance. The reality of qualifying for an extenuating circumstance exception is that there are very few situations that I have ever seen get approved.
Keep in mind that this is my personal experience, and that there is no “standard” extenuating circumstance. Every person’s situation is different. Here are the most common extenuating circumstances exceptions I’ve seen:
FHA Extenuating Circumstances
- Back to Work Program – EXPIRED September 30th, 2016 – Loss of income resulting in minimum 20% loss of household income over a 6 months period. Must still meet all “standard” extenuating circumstances criteria and be thoroughly documented.
- Death of Primary Wage Earner – Resulting in significant loss of income. If this leads inability to meet financial obligations s a direct, documentable result of this loss of income, an extenuating circumstances exception is likely to be within reach.
- Permanent Disability of Primary Wage Earner – Resulting in significant loss of income. If this leads inability to meet financial obligations s a direct, documentable result of this loss of income, an extenuating circumstances exception is likely to be within reach.
Conventional Extenuating Circumstances
Conventional financing tends to be much more flexible, and yet extremely vague about extenuating circumstances. The definition of extenuating circumstances per Fannie Mae guidelines is as follows:
Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.
If a borrower claims that derogatory information is the result of extenuating circumstances, the lender must substantiate the borrower’s claim.
Examples of documentation that can be used to support extenuating circumstances include
- documents that confirm the event – such as a copy of a divorce decree, medical reports or bills, notice of job layoff, job severance papers, etc.; and
- documents that illustrate factors that contributed to the borrower’s inability to resolve the problems that resulted from the event – such as a copy of insurance papers or claim settlements, property listing agreements, lease agreements, tax returns (covering the periods prior to, during, and after a loss of employment), etc.
The lender must obtain a written explanation from the borrower explaining the relevance of the documentation.
The written explanation must support the claims of extenuating circumstances, confirm the nature of the event that led to the bankruptcy or foreclosure-related action, and illustrate that the borrower had no reasonable options other than to default on his or her financial obligations.
The written explanation may be in the form of a letter from the borrower, an email from the borrower, or some other form of written documentation provided by the borrower.
As you can see, it’s purposely kind of vague, while seeming to identify several circumstances that it accepts as a qualifying event.
To have a successful conversation about extenuating circumstances, you need to be working with a loan officer that has experience getting these exceptions approved.
It takes an experienced loan officer to put the exception request together, and it takes an experienced underwriter to accept the risk, and make the exception.
FICO Score – aka Your Credit Scores
A FICO score is a credit score developed by FICO, a company that specializes in what’s known as “predictive analytics,” which means they take information and analyze it to predict what’s likely to happen.
What does FICO mean? Similar to the way Federal Express eventually became FedEx, the company that develops FICO scores used to be called Fair Isaac Co. It was often shortened to FICO and a few years ago that became the official name.
The word FICO pretty much just refers to your credit scores. Your qualifying FICO score, as set by each loan program, is the middle score of your three credit scores from Equifax, Experian, and TransUnion.
If you have only two scores, the lower of the two will be used as your qualifying FICO.
GFE – Good Faith Estimate
The good faith estimate has been replaced by the Loan Estimate (LE) October 2015. The term loan estimate caught on pretty well in the industry, and lenders should never be using the term GFE to describe the discussion of your loan’s fees.
I will typically use a fees worksheet when we are in the very early discovery stages of looking at different options, which is a standard format that most loan officers have in their loan processing software.
HOA – Homeowners Association
A homeowner’s association (HOA) is an organization in a subdivision, planned community or condominium that makes and enforces rules for the properties within its jurisdiction.
The purchase of the property automatically makes the homeowner a member of the HOA and dues are required. Some associations can be very restrictive about what members can do with their properties.
Homeowners Insurance / Hazard Insurance
If you have a home loan, you are required to carry a homeowners insurance policy. The loss payee of the policy needs to be the new lender. This is one of the most critical steps, and is often the last thing we are waiting on, causing loan documents to be delayed.
If you are buying a Condo, your lender will most likely ask for an HO-6 policy. Another name for condo insurance is “walls in”. In a condominium community, your HOA dues go partially to carry a master insurance policy to cover the community as a whole.
Pro Tip: Many insurance companies will offer really good discounts if you have your home and auto with them. Ask your auto insurance company what kind of discounts they can offer you! Secure your insurance as soon as escrow is open to avoid future delays.
LE – Loan Estimate
A Loan Estimate is a three-page form that you will receive as soon as you have met the six minimum required criteria that qualifies as a loan application. The six items that require that a Loan Estimate be sent are:
- Your name
- Your income
- Your Social Security number (so the lender can check your credit)
- The address of the home you plan to purchase or refinance
- An estimate of the home’s value or purchase price
- The loan amount you want to borrow
You do not need to have all six of the above items to receive a loan estimate, it is most likely that you will receive the loan estimate once you’ve already agreed to work with your loan officer, with the terms your loan officer has offered.
The Loan Estimate essentially provides you with all of the closing costs and terms of the loan. You typically would not receive a Loan Estimate if you are in the very early stages of trying to qualify for a purchase money loan because you do not know what the address of the property is, or what the purchase price/home value is.
Your lender must provide you a Loan Estimate within three business days of receiving your application.
When you receive a Loan Estimate, the lender has not yet approved or denied your loan application. The Loan Estimate shows you what loan terms the lender expects to offer if you decide to move forward. If you decide to move forward, the lender will ask you for additional financial information.
Additional Reading: See a sample Loan Estimate form with interactive tips and definitions.
The Community Facilities Act (more commonly known as Mello-Roos) was a law enacted by the California State Legislature in 1982. The name Mello-Roos is derived from its co-authors, Senator Henry J. Mello (D-Watsonville) and Assemblyman Mike Roos (D-Los Angeles).
The Act enabled “Community Facilities Districts” (CFDs) to be established by local governments in California as a means of obtaining additional public funding.
Counties, cities, special districts, joint powers authority, and schools districts in California use these financing districts to pay for public works and some public services.
What this ultimately means to you is that the “cost” of living in a Mello-Roos neighborhood is higher than living in a community that does not have this tax.
MCC – Mortgage Credit Certificate
A Mortgage Credit Certificate, commonly known as MCC, is a dollar for dollar tax credit similar to the first time homebuyer tax credits we saw in 2008 and 2009, that will directly reduce the amount of taxes you will have to pay, or get refunded at the end of the year.
The math for MCC programs is the same all over, but I’m going to specifically focus on the The State of California MCC offered through the California Housing Finance Agency (CalHFA), my home State.
The CalHFA Mortgage Credit Certificate is a tax credit program that offers a federal income tax credit, which can reduce your federal income tax liability. This credit creates additional net spendable income which you may use toward your monthly mortgage payment.
Additional Reading: How Do Mortgage Credit Certificates Work?
I’m not sure how mortgage insurance got such a bad rap, but it seems that public opinion is that it’s a bad thing. I couldn’t disagree more. Mortgage insurance is a premium you pay to allow you to put as little money down as possible.
There is also a lot of confusion about how mortgage insurance works. The short and sweet definition is that mortgage insurance is an insurance policy that helps to protect the lender in the event of you defaulting on the loan.
This insurance is required if you have less than 20% equity in your home. If you’re purchasing a home, that’s a 20% down payment.
Let’s look at the two most common types of mortgage insurance that most borrowers will encounter. The easiest way to differentiate between these policies is by which type of loan program they are tied to.
Conventional – PMI
Private Mortgage Insurance (PMI) is required anytime you are using a non-Government insured loan, and have less than 20% equity as a homeowner, or 20% down as a homebuyer.
One of the advantages of using PMI is that at the time of application, the insurance rate is determined by the loan to value. The higher the loan as a percentage of the value, the higher the PMI rate.
I have found that with a credit score less than 680, FHA has a lower mortgage insurance payment above 90% loan to value.
FHA – MIP / UFMIP
FHA requires two separate payments when you use a Government insured loan.
The first payment is called Up Front Mortgage Insurance Premium (UFMIP) and is current set at 1.75% of the total loan amount. For example, on a $100,000 loan, the UFMIP is $1,750, which is normally financed into the loan.
The second payment is included in your monthly mortgage payment and is called a Mortgage Insurance Premium (MIP). Currently the FHA MIP rate is .85%.
FHA mortgage insurance rates are set by HUD and will not change based on loan to value like PMI can. I have also seen PMI rates as high as 1.65%, twice the payment of the FHA mortgage insurance premium.
Still not sure which is right for you?
Additional Reading: Mortgage Insurance – PMI vs FHA, Which is Better?
Pre-qualification and pre-approval often get used interchangeably and shouldn’t be. One of the most common challenges that home buyers have when buying a home is that their “pre-approval” wasn’t really as solid as you thought it was.
A true loan approval should only come after providing details about your personal and financial situation. An experienced loan officer does not necessarily need to run your file through the AUS to know if you qualify.
You should expect to provide the following documentation to support the information you will need to provide to your loan officer:
Critical – core qualifying criteria
- Last 30 days pay stubs (all borrowers)
- Last 2 years tax returns (all schedules)
- Last 2 years W2’s (all borrowers)
- Credit report – (give permission)
Optional – will be required later
- Last 60 days asset statements (down payment source)
- Current drivers license (all borrowers)
- Social Security card (all borrowers)
- Signed Borrower’s Authorization Form
A pre-approval letter is required by when you are making an offer on a home. This letter should come as a result of your lender receiving and reviewing your credit, income and assets. Your real estate agent will ask your lender to provide a Pre-Approval letter, and at the very least, AUS findings showing that you are pre-approved.
Not to be confused by a Pre-Approval, a Pre-Qualification is a cursory collection of information from you, and an educated guess by your loan officer.
Hopefully, you are lucky enough to get an experienced loan officer that would only lead you to believe you are approved, if you are actually approved. There are many loan officers out there that will offer pre-qualification opinions without the experience to back up their talk.
The loan officer is not the only one to blame for blatantly wrong opinions about your ability to qualify for a home loan, it’s also the borrowers fault (that’s you!) for not asking enough questions.
Expect, and be prepared to provide all of the important paperwork required to exponentially increase the accuracy of your approval.
If you are serious about qualifying, see Pre-Approval.
Different sources and types of income are calculated in different ways. What you might think your income is one thing, and what the lender is allowed to use based on the underwriting guidelines might be a completely different number.
The one thing that can surprise inexperienced loan officers and borrowers is how variable income is calculated. Examples of variable income include:
- Part time job
- Second job
Before being able to use any of the above income, you must have a 2 year history of receiving this income, then it will be averaged over the previous 2 years tax returns.
There are exceptions to the 2 year guideline, and income from these sources must be increasing year over year. Decreasing variable income year over year may not be included in your qualifying income.
Salary and hourly W2 income is treated as your current income is your income. No averaging.
At the end of the day, you cannot get Pre-Approved without knowing what your qualifying income actually is. And that requires that your loan officer review your pay stubs, W2 and tax returns in order to confidently issue you an accurate answer about your home loan options.
Additional Reading: How Lenders Calculate Qualifying Income
TIP – Total Interest Percentage
The total interest percentage is calculated by adding up all of the scheduled interest payments, then dividing the total by the loan amount to get a percentage.
The calculation assumes that you will make all your payments as scheduled. The calculation also assumes that you will keep the loan for the entire loan term.
For example, if you have a $300,000 loan and your TIP is 50 percent, that means that you will pay a total of $150,000 in interest over the life of the loan, in addition to repaying the $300,000 that you borrowed.
If your TIP is 100 percent, that would mean that you will pay $300,000 in interest (100 percent of the $300,000 loan amount) over the life of the loan.
You can find the TIP for your loan on page 3 of your Loan Estimate or page 5 of your Closing Disclosure. The TIP is most useful as a comparison point between different Loan Estimates.
If your Loan Estimate is for an adjustable-rate mortgage (ARM), the TIP is calculated using current interest rates. The actual amount you pay could be more or less, depending on how rates change in the future.
TIL – Truth in Lending
The Loan Estimate and Closing Disclosure replaced the Truth in Lending form on October 3rd, 2015.