Real Estate Alphabet Soup

If you look down the street, chances are you might see a house that has recently faced foreclosure. The last couple of years have been ripe with poor financial planning and the results have been felt throughout the country. Not only have individuals made poor choices on how to borrow and spend their money, but lenders have as well, lowering standards to a dangerous level, thus making it far too easy to receive a home loan. The result, the mortgage meltdown.

Call me an idealist, but I can’t help but wonder how many of these homes could have been saved, how many bankruptcies could have been avoided, if people had simply done their homework. As I mentioned before in my previous Alphabet Soup post on investing, half the battle in understanding any of these areas is simply learning the language. People often fail to ask questions not just because they don’t want to feel stupid, but because the don’t even know what questions to ask.

With this in mind, and in an effort to keep readers of Schaefer’s Blog well ahead of the financial education bell curve, I have singled out some common real estate terms that everyone should know. Whether you plan on buying, selling, or renting there are some terms and concepts that can benefit anyone as they walk through the process.

In knowing the language, the element of fear is greatly diminished and you will be much more confident in asking the right questions and getting the answers you need to make wise financial decisions.

With that in mind, here are five real estate terms every person should know:

Adjustable Rate Mortgage (ARM) – Yes, this is the three-headed monster that you have been hearing thrown about in the news for quite sometime now. An ARM is a type of loan in which the interest rate that you pay for borrowing the money is periodically adjusted based on what market rates are doing.

The interest rate you pay is tied to an index of some kind (common ones include the Treasury 1-year Constant Maturity series (CMT), and the Cost of Funds Index (COFI)).  On top of this, you pay an additional premium, also called a margin (additional interest on top of the index rate).  The premium is fixed and will not change during the loan, but the interest rate is variable.

There are many different types of ARM’s and many have a fixed interest rate for an initial period, normally anywhere from 1 month to 5 or more years, before they begin adjusting and following the market rates.  If you see numbers in front of an ARM such as 5/1 ARM:

• The first number is how long you will have a fixed interest rate (5 years)
• The second number is how often the rate will adjust after the initial fixed period (annually)

Finally, because an ARM transfers some of the risk from the lender to the borrower you can normally receive a lower initial interest rate (and therefore monthly payment) on an ARM than you can with a traditional fixed-rate mortgage.  So, if you plan on not being in your house for very long, an ARM might be the way to go, but there are several other factors to consider.  Here are some great questions to ask taken straight from the Federal Reserve Board website:

• Is my income enough–or likely to rise enough–to cover higher mortgage payments if interest rates go up?
• Will I be taking on other sizable debts, such as a loan for a car or school tuition, in the near future?
• How long do I plan to own this home? (If you plan to sell soon, rising interest rates may not pose the problem they do if you plan to own the house for a long time.)
• Do I plan to make any additional payments or pay the loan off early?

For more great information on ARM’s see here.

Closing Costs – also, known as “settlement costs,” they are the various expenses and fees on top of the price of the property that a buyer must pay during closing (when you sign the papers to purchase the property).  The following are some of the ordinary closing costs courtesy of REMAX of Parker, CO:

1. Loan Organization Fee: This fee is usually equal to 1% of your mortgage.
2. Discount Point(s): Each point is also 1% of your mortgage.
3. Cost of Title Search: Mandatory to ensure you are buying the property from the current owner.
4. Lender’s Title Insurance Fee
5. Survey Fee(if Applicable): The cost of surveying your property if not done already.
6. Transfer Tax: State and/or Local taxes, stamps etc. for property transfer of ownership. This fee is sometimes split among the buyers and sellers.
7. Lender’s Appraisal Fee
8. Recording Fees: Cost of turning closing documents into public records.
9. Prepaid Mortgage Insurance Premium: First payment.
10. Property Tax Escrows
11. Lawyer’s or escrow company’s fee

Earnest Money – money that a buyer gives accompanying an offer on a property to show that they are serious about making the purchase.  The amount varies from state to state (generally 1-3% of purchase price) and is often held in real estate broker’s trust until closing when it is then credited back to the buyer.

Equity – the difference between what a property is worth and how much the buyer still owes on it.  Basically, how much of the property you actually own.  So, if you still owe $150,000 on a $200,000 property, you have $50,000 in equity.  Equity is good…get some!

Escrow – assets (money, property, deed, etc.) put into the safekeeping of a third party until the conditions of an agreement are met.  When buying a house it is common that a,  “mortgage company establishes an escrow account to pay property tax and insurance during the term of the mortgage” (Wikipedia).  The escrow company, in a sense, acts as a savings account for a borrower in that money is deposited and used to pay interest and taxes.

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