If you've ever shopped for a mortgage, you've probably been overwhelmed by an alphabet soup of acronyms seemingly designed to confuse the borrower at every turn.
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While the lingo may seem complex, the definitions aren't all that daunting. Here are the basics.
GFE and HUD-1
A good faith estimate, or GFE, is a document that lenders are required to provide prospective borrowers detailing the estimated costs of the mortgage loan. The costs listed on the GFE typically include the lender's origination fee, points (if any), escrow or attorney's closing fees, title insurance, appraisal fee, and various other taxes and expenses. However, the exact list will vary by state, and borrowers should remember that the actual cost of the loan can change.When the mortgage officially closes, lenders are required to state the actual costs of the loan on a HUD-1 form. (HUD is an acronym for the Department of Housing and Urban Development.) The HUD-1 should track with the GFE, but it can also include other costs, such as a broker's commission, which might not have been included in the original estimate.
A debt-to-income ratio, or DTI, is how a lender determines how much a borrower can afford to pay every month. By dividing the borrower's monthly liabilities by monthly income before taxes, the lender arrives at a percentage. To qualify for the mortgage, borrowers usually need to fall below certain thresholds.
Typically, lenders don't want the monthly house payment to exceed 28% of income, and don't want all debt payments (house, auto, credit cards, student loan) to exceed 36% of income. Thresholds can vary by lender.
LTV and CLTV
An LTV, or loan-to-value, is one of the key ratios that lenders use to assess the risk of a loan. The ratio is the mortgage divided by the purchase price or appraised value of the property. When a property has multiple mortgages, lenders use a combined loan-to-value ratio, or CLTV.Borrowers with an LTV or CLTV of less than 80% often get lower interest rates because lenders view them as less risky.
RESPA and TILA
The Real Estate Settlement Procedures Act, or RESPA, and the Truth in Lending Act, or TILA, are the two main pieces of federal legislation that govern mortgage lending to consumers.Among other things, RESPA requires lenders to provide borrowers with a GFE within three days of applying for a loan as well as the HUD-1 at or before closing. TILA requires lenders to provide borrowers with clear terms and costs of a loan.
PMI and MIP
Private mortgage insurance, or PMI, is paid by the borrower to protect the lender's investment when the borrower makes a down payment of less than 20% on a home purchase, or when the borrower has less than 20% equity in a refinance.
But don't let the name fool you. The borrower pays the premium and the lender gets the benefit in the event of default. On a loan insured by the Federal Housing Administration, the borrower pays a mortgage insurance premium, or MIP.
An adjustable-rate mortgage, or ARM, is a home loan in which the interest rate can change based on movement in an agreed-upon index, such as the London Interbank Offered Rate, or Libor.
Usually, ARMs start with lower rates than fixed loans. But there's always the risk that the borrower can eventually end up paying more than if he or she had secured a fixed rate.
A home equity line of credit, or HELOC, allows homeowners to borrow cash against home equity. Unlike a second mortgage, borrowers can take what they need (up to the limit) and return for additional funds.
The credit limit is often determined by the loan-to-value ratio. Often a HELOC will have a variable rate.
VOR, VOM, VOD, VOE, and IRS Form 4506-T
When you apply for a home loan, the lender will want to verify what you said about your personal finances. While different lenders will require different levels of documentation, the process will typically involve some or all of the following forms: verification of rent, or VOR, verification of mortgage, or VOM, verification of deposit, or VOD, and verification of employment, or VOE.
Each form will allow the lender to contact a party in the position to confirm some aspect of your finances. Borrowers usually are asked to provide Internal Revenue Service Form 4506-T, which allows the lenders to see transcripts of tax returns.
Best understood as the bottom line on a monthly mortgage loan, PITI represents the sum total of principal, interest, taxes, and insurance costs. It's the monthly house payment. Lenders divide PITI by the borrower's pretax monthly income to calculate DTI -- the debt-to-income ratio.