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Mortgages Key Terms

Ability-to-repay rule – The ability-to-repay rule is the reasonable and good faith determination most mortgage lenders are required to make that you are able to pay back the loan.

5/1 Adjustable Rate Mortgage – A 5/1 adjustable rate mortgage (ARM) or 5-year ARM is a mortgage loan where “5” is the number of years your initial interest rate will stay fixed. The “1” represents how often your interest rate will adjust after the initial five-year period ends. The most common fixed periods are 3, 5, 7, and 10 years and “1,” is the most common adjustment period. It’s important to carefully read the contract and ask questions if you’re considering an ARM.

Adjustable Rate Mortgage (ARM) – An adjustable rate mortgage (ARM) is a type of loan for which the interest rate can change, usually in relation to an index interest rate. Your monthly payment will go up or down depending on the loan’s introductory period, rate caps, and the index interest rate. With an ARM, the interest rate and monthly payment may start out lower than for a fixed-rate mortgage, but both the interest rate and monthly payment can increase substantially.

Amortization – Amortization means paying off a loan with regular payments over time, so that the amount you owe decreases with each payment. Most home loans amortize, but some mortgage loans do not fully amortize, meaning that you would still owe money after making all of your payments.  Some home loans allow payments that cover only the amount of interest due, or an amount less than the interest due. If payments are less than the amount of interest due each month, the mortgage balance will grow rather than decrease.  This is called negative amortization. Other loan programs that do not amortize fully during the loan may require a large, lump sum “balloon” payment at the end of the loan term. Be sure you know what type of loan you are getting.

Amount financed – It means the amount of money you are borrowing from the lender, minus most of the upfront fees the lender is charging you.

Annual income – Annual income is a factor in a mortgage loan application and generally refers to your total earned, pre-tax income over a year. Annual income may include income from full-time or part-time work, self-employment, tips, commissions, overtime, bonuses, or other sources.  A lender will use information about your annual income and your existing monthly debts to determine if you have the ability to repay the loan.  Whether a lender will rely upon a specific income source or amount when considering you for a loan will often depend upon whether you can reasonably expect the income to continue.

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