The following contribution comes from one of our FM Lending Loan Officers, Hugh Page. Once again, thank you for providing valuable insight for potential home buyers in the Raleigh, Durham, Chapel Hill market!
Many terms are used in the mortgage lending world and condensed down to simple initials to describe certain aspects of the lending process. Mortgage professionals throw these terms around daily with ease but we tend to forget that consumers often have no idea what we are talking about. Here’s a list of some of the most common initials thrown around and a brief rundown on what they stand for.
APR – is an acronym for Annual Percentage Rate. It’s a government-mandated calculation meant to simplify the comparison of mortgage options. A loan’s APR can always be found in the top-left corner of the Federal Truth-In-Lending Disclosure. Because APR is expressed as a percentage, many people confuse it for the loan’s interest rate. It’s not. APR represents the total cost of borrowing over the life of a loan. “Interest rate” is the basis for monthly mortgage repayments.
The main advantage of APR is that it allows an “apples-to-apples” comparison between loan products. As an example, a 5.000 percent mortgage with origination points and fees will almost certainly have a higher APR than a 5.500 percent mortgage with zero fees. In this sense, APR can help a borrower determine which loan is least costly long-term.
However, APR is not without its shortcomings.
First, different banks may include different fees into their APR calculations. By definition, this spoils APR as choose-between-lenders, apples-to-apples comparison method. And, second, when calculating APR, “life of the loan” is assumed to be full-term. When a 30-year mortgage pays off in 7 years or fewer — as most of them do — APR comparisons are rendered moot. In other words, APR is just one metric to compare mortgages — it’s not the only metric. The best way to compare your mortgage options is to review all the loan terms together and determine which is most suitable.
FICO – is an acronym for Fair Isaac Credit Organization. The Fair Isaac Corporation is a company that provides credit scoring information to lenders. When someone asks “what’s your FICO score” they’re asking if you know your credit score. In reality FICO is just the score from one company and mortgage lenders use the median score from all 3 credit bureaus.
HELOC – is an abbreviation for Home Equity Line of Credit. A HELOC is a Second Mortgage taken out against the available equity in your home. Since it’s a line of credit it works just like a revolving credit card in that any balances used and paid off become available to be used again in the future. Interest rates are typically variable based on Prime Rate plus a fixed margin and required monthly payments are usually just interest only. HELOC’s are commonly used for repairs and renovations or upgrades but can be used for anything the borrower chooses.
LTV and CLTV
LTV and CLTV – LTV stands for “Loan to Value” and CLTV stands for “Combined Loan to Value” and is given a percentage number. Many loan programs have limits on the maximum LTV or CLTV allowed and pricing may adjust at varying LTV or CLTV levels. The calculation for the LTV is simply the loan amount divided by the sales price of the home (on a purchase transaction) and the appraised value of the home (on a refinance). The CLTV combines the balance of the 1st Mortgage loan with any 2nd Mortgage Loan or HELOC (which is a 2nd Mortgage) and divides it by the appropriate value or price.
DTI – These initials refer to a borrower’s Debt To Income ratio. Two ratios are used in the mortgage lending process. You have a Housing Expense DTI also known as a “Front End Ratio” and a Total Expense DTI also known as the “Back End Ratio”. Lenders will often have maximum DTI ratios that cannot be exceeded in order to qualify for a mortgage loan. The “Front End Ratio” is the Principal and Interest, 1/12th of Real Estate Taxes and 1/12th of Homeowner’s Insurance plus any Mortgage Insurance as well as any Homeowners Association (HOA) dues or Condo dues on the property divided by the borrower’s gross monthly income. The “Back End Ratio” is simply the total debt considered for the borrower’s Front End Ratio plus all other consumer debt such as minimum credit card payments, car loans, and any other loans the borrower may have divided by the borrower’s gross monthly income.
So now, in the future, when your lender starts throwing around these terms you can act like you know what they’re talking about! As always, contact the Mortgage Professionals at FM Lending Services with any questions you have.