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A
ADJUSTABLE RATE MORTGAGES
(ARMs)
Mortgages in
which, at specified intervals, the interest rate will change
based on a predetermined interest rate index. Interest
payments, and possibly the resulting monthly mortgage
payment due, will change according to movements in interest
rates any time there is a new adjustment period. The
term of an ARM is usually for 30
years, sometimes for as little as 15 years. ARMs are much
less popular and considered to be riskier than fixed
mortgage loans. The risk arises from the borrower having to
bear the impact of future changes in interest rates, since
these changes directly affect the amount of interest due as
a part of monthly mortgage payments (see also
Negative
Amortization). While an ARM's initial interest rate
is usually lower than a fixed mortgage's interest rate, the
rate changes in subsequent adjustment periods will vary
according to the related rate index. To protect against
large shifts in interest rates, many ARMs have caps on how
high interest rates can rise. These caps may address
increases from one adjustment period to another or may cover
the life of the mortgage. See also Balloon
Payment,
Convertible
Mortgages, Fixed Rate
Mortgages
ANNUAL PERCENTAGE RATE
(APR)
The true
rate of return on a loan which includes all interest and
fees pertaining to a particular deposit or loan transaction.
Under the Federal Truth in Lending Act, lenders are required
to disclose the APR of a loan.
B
BALLOON
PAYMENT
A typical
feature of seller-financing, where a loan is offered for a
shorter than normal term, with a large, single payment at
the end of the term. Monthly payments leading up to a
balloon payment may be only interest leading up to a single
repayment of the balance of the loan. Or, monthly payments
may consist of both interest and principal, which are paid
over a shorter than normal term, again with a large single
payment for the remaining balance coming due at the end of
the term. A mortgage with a balloon feature may also have a
reset feature which allows the borrower to forgo the balloon
payment in favor of a continuing mortgage obligation. This
"new" mortgage will have the term of an ordinary mortgage,
less the term of the balloon loan. See also Adjustable
Rate Mortgages, Convertible
Mortgages, Fixed Rate
Mortgages
BANKS
A large,
secondary source of home mortgage funding. Also an important
source of interim loans for home construction. See also
Savings
Institutions
C
CALL
An option to
buy an underlying investment or commodity
at a specified price (strike price). Like all options, a
call has a limited life span and expires on a specified date
(third Friday of a specified month). By purchasing a call,
the buyer of the option pays for the right to determine for
themselves the selling price of the underlying investment.
Therefore, call owners would only exercise their call if the
price of the commodity went above the strike price.
Otherwise, the option goes unused and terminates
automatically on its expiration date. For example, the
purchaser of an underlying investment may want to avoid a
future price increase and, therefore, would purchase a call
to lock in the lowest probable future price at which they
could buy. A call seller (writer) has different price
expectations than the buyer. A writer expects the price of
the underlying investment to go up. Thus, while a call buyer
hopes to save money by avoiding unforeseen higher prices,
the call writer hopes to make a profit by selling an
opportunity to avoid what they believe is an unlikely
outcome. See also Put, Derivatives, Options, Futures
Contracts
CLOSING COSTS
Additional
costs of a home purchase, some of which are application
fees, organization fees, points, title search fees, title
insurance fees, attorney's fees, and home inspection fees.
Many of these costs may vary based on the creditworthiness
of the borrower, funds available to the lender, and the
percentage of the down payment. See also Closing
Statement
CLOSING
STATEMENT
An
accounting by the buyer and seller of all monies changing
hands in a home purchase. All costs arising from the sale
are itemized and assigned to one party or the other. Costs
to the buyer may include contract purchase charges,
deposits, advance mortgage payments, mortgage insurance,
homeowner's insurance, title search and recording, and tax
credits and charges. Costs to the seller may include real
estate commission, affidavit of value, title insurance, home
inspection, and tax credits and charges. By providing
detailed costs, this statement determines the buyer's final
cost of the purchase and the size of the loan needed for the
purchase. The cost detail also helps the seller identify how
much money will be available to pay off their existing
mortgage and the gain or loss on the sale. The statement is
presented to both the buyer and seller at closing.
COMMISSION
FEE
A charge for
services rendered which is assessed in various transactions
by the party which acts as an intermediary.
CONVERTIBLE
MORTGAGES
Adjustable
rate mortgages which give the borrower the option to convert
the loan to a fixed rate mortgage. The initial interest rate
of these mortgages may not be as low as those offered for an
ordinary adjustable rate mortgage. Also, the interest rate
for the fixed portion of the mortgage may not be as low as
those offered for an ordinary fixed rate mortgage.
Convertible mortgages also include a conversion fee.
Typically, the convertible feature can only be exercised in
years two through five. See also Adjustable Rate
Mortgages, Balloon
Payment,
Fixed Rate
Mortgages
COUPON RATE
The annual
interest rate paid by the issuer of a bond to the bond's
holder of record.
D
DEBT SERVICE
RATIO
Total
monthly loan payments divided by monthly pretax income. This
is an important measure of financial health which shows how
easy it is for a consumer to pay their debt obligations by
looking at how much income immediately goes to pay for debt.
A smaller number indicates that less money is spent on
existing debt obligations, leaving more income available to
fund purchases or new debt.
DERIVATIVES
Financial
instruments which do not represent ownership of tangible
items but rather their economic characteristics. By trading
in the financial features of tangible goods, some of the
risk inherent in the trade of actual tangible goods can be
significantly reduced. These instruments are effective for a
fixed duration and usually have well-established markets.
Futures
contracts and options are examples of derivatives.
See also Call, Put
DIVIDENDS
Cash or
stock payments a company makes directly to its stockholders.
Dividends are usually only paid by large, mature companies.
Most dividends are in the form of cash and paid out on a
quarterly basis.
DOWN PAYMENT
The amount
of the full purchase price of a major asset which is paid at
the time of purchase.
E
ESTATE
PLANNING
This
addresses the concerns of providing for both the lifestyle
and the financial needs of yourself and of those close to
you. The plan examines your economic ability to fund the
ongoing way of life for those who do or will rely on your
financial resources to pay for, among other things, job
loss, retirement, illness, disability, education, and
inheritance.
F
FACE VALUE
The
redemption value of a financial instrument. This is a
clearly marked, dollar amount on the face of the
instrument.
FEDERAL HOUSING
ADMINISTRATION
(FHA)
LOANS
The FHA
promotes home ownership for low income borrowers by offering
lenders mortgage insurance when borrowers make a relatively
small down payment. The mortgage itself finances the
overwhelming bulk of the home purchase. There is an
additional charge at closing for this type of loan, and it
is only available to finance homes priced at or below the
area's median home price. See also Conventional
Mortgages, Private Mortgage
Insurance, Veterans
Administration Loans
FINANCIAL
PLANNING
Detailed
recommendations which, over a given time period, address
both the amount and certainty of income, debt, and wealth.
Consumers should address the costs of insurance, housing,
and transportation, as well as general spending behavior,
both now and in the future. Long-term planning should
examine everything from career goals to the desired size of
your family.
FIXED RATE
MORTGAGE
The most
popular home mortgage instrument. A mortgage wherein both
the monthly mortgage payment and the interest rate are fixed
for the term of the loan. As a result, this loan limits risk
to the borrower since only the lender bears the risk of
changes in interest rates. These loans are typically for
terms of 30 or 15 years. See also Adjustable Rate
Mortgages, Balloon
Payment, Convertible
Mortgages
FUTURES
CONTRACTS
Derivative
instruments for the purchase or sale of a fixed amount of an
underlying, tangible commodity, at a set price, until a
fixed date. Like other derivatives, these instruments are
effective for a fixed duration and usually have
well-established markets. Derivatives, Options, Call, Put
G
GROWTH STOCKS
Shares with
high price to earnings ratios. Typically, these stocks pay
little or no dividends at all. Profits are reinvested in the
firm to help cover the costs of growth. See also
Value
Stocks
I
INCOME STOCKS
See
Value
Stocks
INFLATION
When the
same amount of money buys less due to increasing prices.
This condition is indicative of demand increasing relative
to supply and is also associated with an increase in the
money supply.
INTEREST RATE
The rate of
return on deposit accounts, or the portion of the face value
of a debt instrument which is paid over time. The rate is
usually expressed as an annual return even though payments
are made in monthly or quarterly increments.
M
MARGINS AND MARGIN
CALLS
Margin
trading involves the purchase or sale of financial
instruments when the transaction is partially financed (up
to 50% of the purchase price) by borrowing funds from a
broker. In effect, securities are bought and sold without
the investor ever owning them entirely. In order to ensure
repayment of the margin debt, margin calls are issued when
the price of a security bought on margin falls more than
25%. As a result, the stockholder is compelled to sell
shares and use the funds to repay the debt. Additional funds
may be needed to cover the difference between the remaining
value of the security and the value of the debt.
MARGINAL TAX
IMPACT
The amount
of taxes due as a result of applying the marginal income tax
rate to all or a portion of gross income without applying
any adjustments or deductions.
MATURITY DATE
Date on
which the par value of a bond is paid back to the owner of
the bond. On the maturity date, only the bond owner receives
payment.
MORTGAGE
(CONVENTIONAL)
Offered by a
typical lender, this mortgage requires a down payment of
between 5 and 20% of the purchase price. While down payments
can be less than 5%, this will result in higher purchase
costs. Interest rates are determined by many factors: a
borrower's credit history and current capacity to make
payments, size of the loan compared to the purchase price,
and interest rate trends in the general economy. See also
Adjustable Rate
Mortgages, Balloon
Payment,
Convertible
Mortgages, Fixed Rate
Mortgages and Federal Housing
Administration Loans, Veterans
Administration Loans
MORTGAGE
TYPES
See
Adjustable Rate
Mortgages, Balloon
Payment,
Conventional
Mortgages, Convertible
Mortgages, Fixed Rate
Mortgages
MORTGAGE
INSURANCE
Fees
assessed against the mortgage value of a major asset when
the mortgage is for 80% or more of the purchase price of the
asset. These fees compensate the lender in case the borrower
defaults on the loan. These fees can be charged in various
combinations which appear in closing costs and in monthly
payments.
MUTUAL FUND
A collection
of stocks, bonds, or other securities which are owned by
large groups of investors and managed by professional
investment companies. These funds may focus on holding a
particular kind of security, from a specific industry, from
a particular region, or with a particular maturity. Funds
are also focused to provide various combinations of risk
exposure, rate of return, and income levels.
N
NEGATIVE
AMORTIZATION
When monthly
mortgage payments are less than the interest charges on the
outstanding balance of the loan, an adjustable rate mortgage
(ARM) produces an increasing
principal balance. This can occur when the initial payments
on the loan are too small or when the interest rate on the
mortgage significantly increases while the monthly payment
remains fixed.
NET PRESENT VALUE
(NPV)
An
investment evaluation process which utilizes the
present
value of
money concept to value current and future cash flows in
today's dollars. This allows for a direct, side-by-side
comparison of funds from today and tomorrow. NPV is equal to
investment returns discounted over time less the costs of
the investment discounted over time. A point worthy of note
is that the future dollar value of a project's income and
expenses will be worth less in today's dollars, the farther
into the future they occur. These future financial flows
will be discounted at an appropriate annual percentage rate
(APR), compounded over time from
the future period, to compute the value of all cash flows in
today's dollars. This is illustrated in the example
below:
Which is
worth more to you? $15,000 today or $30,000 in 3 years for
which you pay $10,000 today?
$15,000 today is worth $15,000. There is no cost to this
option, only income. And, since this transaction takes place
today, no NPV calculations are needed. Therefore, this
option has an NPV of $15,000 ($15,000 - 0 = $15,000).
$30,000 in three years, at an APR of 8% is worth $13,814.97
today. See below.
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Years
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0
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1
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2
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3
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Amount
Received
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x
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x
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x
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$30,000
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Annual
Interest Rate
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8.0%
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8.0%
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8.0%
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x
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Compounded
Interest Rate
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25.97%
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16.64%
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8.0%
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x
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Present
Value:
Payment Received
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$23,815
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$25,720
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$27,778
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$30,000
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Amount
Paid
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($10,000)
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x
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x
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x
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NPV:
Received - Paid
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$13,815
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x
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x
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x
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In Year 3, the $30,000
payment is received
In Year 2, Year 3's payment will be worth: $30,000 / 1.08 =
$27,777.78
In Year 1, Year 3's payment will be worth: $27,777.78 / 1.08
= $25,720.16
In Year 0 (Today), Year 3's payment will be worth:
$25,720.16 / 1.08 = $23,814.97
This option costs you $10,000 today. Deducting costs from
income, both in today's dollars, produces a positive NPV of
$13,814.97 ($23,814.97 - $10,000 = $13,814.97 ). However,
this NPV is smaller than the NPV of the first option.
Therefore, NPV analysis indicates that the first option is
your best choice, since you will be better off by $1,185.03
($15,000.00- $13,814.97 = $1,185.03).
O
OPPORTUNITY
COSTS
The expected
return or benefits that are foregone by making an investment
or purchase rather than just investing in comparable
financial instruments.
OPTIONS
A derivative
instrument designed to emulate certain features of the
underlying commodity or financial instrument(s). See also
Derivatives, Futures
Contracts, Call, Put
P
PAR VALUE
(BOND)
Redemption
amount of the bond. This is the value that will be repaid at
maturity. Most bonds are issued in $1,000 increments.
POINTS (ON A
MORTGAGE)
Fees charged
by the lender at the time the loan is granted. These are
expressed as percentages of the amount borrowed and are
based on the lender's availability of funds at the time of
the loan.
PRESENT VALUE
CONCEPT
A financial
estimation technique which determines the economic impact of
projects which produce cash flows over time. It expresses a
project's future income and expenses in terms of today's
dollar value. See also NPV
PRIVATE MORTGAGE
INSURANCE
Programs
which are similar to FHA and VA loan programs which provide
mortgages to borrowers who have furnished a down payment
which is a very small fraction of the purchase price. The
smaller the down payment is relative to the size of the
home's purchase price, the more charges that will be
assessed, both at closing and in monthly payments. See also
Conventional
Mortgages, Federal Housing
Administration Loans, Veterans
Administration Loans
PUT
An option to
sell an underlying investment or commodity
at a specified price (strike price). Like all options, a put
has a limited life span and expires on a specified date
(third Friday of a specified month). Therefore, put owners
would only exercise their call if the price of the commodity
went below the strike price. Otherwise, the option goes
unused and terminates automatically on its expiration date.
By purchasing a put, the buyer of the option pays for the
right to determine for themselves the selling price of the
underlying investment. For example, the seller of an
underlying investment may want to avoid a future price
decrease and, therefore, would purchase a put to lock in the
highest probable future price at which they could sell. A
put seller (writer) will have different price expectations
than the buyer. A writer will expect the price of the
underlying investment to go up. So while a put buyer hopes
to save money by avoiding unforeseen lower prices, the call
writer hopes to make a profit by selling an opportunity to
avoid what they believe is an unlikely outcome. See also
Call, Derivatives, Futures
Contracts, Options
R
RATE OF
RETURN
The
proportion by which an investment's value increases or
decreases relative to its purchase price. It is usually
expressed as a percentage.
REAL ESTATE SALES
CONTRACT
State laws
usually require that in order to be enforceable, real estate
sales agreements must: be in writing, list the names of the
buyer and seller, describe the property sufficiently for
positive identification, specify price and terms, and be
signed by both parties. The contract may also address
contingencies, closing costs, earnest money deposits, and
related personal property issues.
REAL ESTATE SETTLEMENT
PROCEDURES ACT (RESPA)
Under this
1974 federal law, costs are required to be disclosed to home
buyers in advance of the sale. By requiring these financial
disclosures so early in the process, the buyer has enough
information and freedom to shop around for the best
financing. This also discourages kickbacks to help
facilitate the closing process, since most of the hurdles
are disclosed ahead of time and any significant hurdles are
usually discovered early in the closing process.
RETURN ON
INVESTMENTS
The commonly
used measure of the growth of an investment's value.
Expressed as a rate of
return.
S
SAVINGS
INSTITUTIONS
The primary
source for home financing, either by funding loans
themselves with deposits from account holders or by
originating loans for resale to third parties. See also
Banks
SHORT SELLING
A limited
opportunity to profit from the decrease in value of a stock
or other equity issue. Shares are borrowed from a broker and
then sold in anticipation that the value of the shares will
decrease before they are returned. Ideally, the stock price
drops and the shares are repurchased at the new, lower
price. Short sellers profit by keeping the difference
between the higher selling price and the lower repurchase
price. The account is settled by returning to the broker
what is owed, a fixed number of shares plus interest and
commissions.
SOCIAL SECURITY SURVIVOR
BENEFITS
Government
payments to the dependents of a deceased worker. Recipients
of these payments include disabled dependents, elderly
dependents, surviving spouses age 60 and over, non-working
spouses with children under 16, and unmarried children under
18.
T
TERM
In mortgage
terminology, this refers to the length of time of the
mortgage obligation.
TERM LIFE
INSURANCE
This type of
policy will only pay a benefit if the insured dies within
the coverage period. These policies are issued only for
fixed periods, during which time, no cash value accumulates.
Straight term policies are issued only for a certain number
of years. Renewable term policies are straight term policies
which can be renewed at expiration. Convertible term
policies can be converted to whole life insurance policies.
While there are more costs associated with term policies
which are other than just straight term, the primary benefit
of these other kinds of term coverage is that the insured
usually avoids having to prove that he/she is insurable any
time a new policy is undertaken. Premiums must be paid in a
timely manner. See also Universal Life
Insurance, Whole Life
Insurance
TRADE IN
VALUE
The amount
of payment toward your purchase which a seller is willing to
pay in return for accepting your asset into his/her
inventory.
U
UNIVERSAL LIFE
INSURANCE
This type of
coverage has features of whole life and term insurance in
this type of whole life
insurance. It provides both a death benefit and
a tax-sheltered cash value. Premiums for these policies are
divided in order to separately fund the administrative costs
portion and the cash value portion. The cash value funds are
usually invested at a rate tied to market interest rates.
Periodic deductions are automatically made to the cash value
account for death benefits coverage for that period. The
policy is in effect as long as the death benefit deduction
does not exceed the balance of the cash value account. See
also Term Life
Insurance
V
VALUE STOCKS (OR INCOME
STOCKS)
Equities
with low price to earnings ratios. The perception is that
these stocks have below average future growth prospects.
Typically, these are shares of larger, more established
corporations which regularly pay quarterly dividends. See
also Growth
Stocks
VETERANS ADMINISTRATION
(VA) LOANS
Home loans
for eligible veterans of the U.S. Armed Forces or their
unmarried surviving spouses which require little or no down
payment and charge no mortgage insurance fees. Maximum
lending amounts apply. See also Conventional
Mortgages, Federal Housing
Administration Loans, Private Mortgage
Insurance
W
WHOLE LIFE
INSURANCE
This policy
pays a benefit if the insured dies at anytime after the
policy begins. It accumulates cash value in addition to
death benefits. Whole life can be purchased with a single
premium payment (one payment at the start of the policy to
cover the remaining life of the insured), continuous
premiums (payments which remain fixed for the life of the
policy),or limited premiums (payments which are assessed
only for a portion of the life of the policy). In addition,
whole life policyholders have a non-forfeiture right. This
entitles the policyholder upon cancellation, made prior to
the death of the insured, to the cash value of the policy.
Premiums must be paid in a timely manner. See also
Term Life
Insurance, Universal Life
Insurance
Y
YEARLY COUPON
RATE
A bond's
annual interest rate.
YIELD (Bond)
($Annual
Interest / $Price) = Yield%
YIELD TO CALL
Changes in
the yield formula which account for differences between the
time the bond is sold and the time the bond matures. This
addresses changes in price between a bond's maturity value
and its predetermined call price before maturity, and
differences between the total amount of interest to be paid
before maturity and the actual interest payments
received.
YIELD TO MATURITY
(YTM)
Includes the
same variables as the Yield to Call scenario but the
duration for which the bond is held is fixed (until
maturity), and, therefore, the selling price of the bond
becomes the face value.
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