Amortization describes the repayment of a debt by regular monthly payments that consist of interest and part of the principal, made over the term of the loan, after which the entire debt has been repaid. A mortgage is amortized when it is repaid with periodic payments over a particular term. After a certain portion of each payment is applied to the interest on the debt, any remaining balance reduces the principal.
Annual Percentage Rate (APR)
A measure of the cost of credit, expressed as a yearly rate. It includes interest as well as other charges. Because all lenders follow the same rules to ensure the accuracy of the annual percentage rate, APR gives you a good basis for comparing the cost of loans, including mortgage plans.
Adjustable-Rate Mortgage (ARM)
A mortgage where the interest rate is not fixed, but changes during the life of the loan in line with movements in an index rate. You may also see ARMs referred to as AMLs (adjustable-mortgage loans) or VRMs (variable-rate mortgages).
When a home is sold, the seller may be able to transfer the mortgage to the new buyer. This means the mortgage is assumable. Lenders generally require a credit review of the new borrower and may charge a fee for the assumption. Some mortgages contain a due-on-sale clause, which means that the mortgage may not be transferable to a new buyer. Instead, the lender may make you pay the entire balance that is due when you sell the home.
With a buydown, the seller pays an amount to the lender so that the lender can give you a lower rate and lower payments, usually for an early period in an ARM. The seller may increase the sales price to cover the cost of the buydown. Buydowns can occur in all types of mortgages, not just ARMs.
A limit on how much the interest rate or the monthly payment can change, either at each adjustment or during the life of the adjustable-rate mortgage. Payment caps don't limit the amount of interest the lender is earning, so they may cause negative amortization.
A provision in some ARMs that allows you to change to a fixed-rate mortgage at some point during the term. Usually conversion is allowed at the end of the first adjustment period. At the time of the conversion, the new fixed rate is generally set at one of the rates then prevailing for fixed-rate mortgages. The conversion feature may be available at extra cost.
In an ARM with an initial rate discount, the lender gives up a number of percentage points in interest to give you a lower rate and lower payments for part of the mortgage term (usually for one year or less). After the discount period, the ARM rate will probably go up depending on the index rate.
A mortgage in which the interest rate remains unchanged for the term of the loan.
The index is a measure of interest rate changes that the lender uses to decide how much the interest rate on an ARM will change over time. No one can be sure when an index rate will go up or down. Some index rates tend to be higher than others, and some more volatile. But if a lender bases interest rate adjustments on the average value of an index over time, your interest rate would not be as volatile. Ask your lender how the index for any ARM you are considering has changed in recent years, and find out where that information is reported.
The number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment.
Through the process of amortization, you reduce your debt gradually by making scheduled monthly payments. Negative amortization occurs when the monthly payments do not cover all of the interest cost. The interest cost that isn't covered is added to the unpaid principal balance. This means that even after making many payments, you could owe more than you did at the beginning of the loan. Negative amortization can occur when an ARM has a payment cap that results in monthly payments not high enough to cover the interest due.
A point is equal to one percent of the principal amount of your mortgage. For example, if you get a mortgage for $65,000, one point equals $650. Lenders frequently charge points in both fixed-rate and adjustable-rate mortgages in order to collect interest income up front. In return, they will usually lower the interest rate for the term of the loan. These points usually are collected at closing. They may be paid by the borrower or the home seller, or may be split between them.