If you’ve ever shopped for a mortgage, you’ve probably been overwhelmed by an alphabet soup of acronyms that seem to be designed to confuse the borrower at every turn. The lingo is complex, but the definitions aren’t hard to understand. Here are the basics.
LE and CD
The loan estimate, or LE, is a document that provides details about a mortgage that the borrower has applied for. The lender is required to mail or deliver it within three business days of the loan application.
The LE describes the interest rate on the mortgage, shows whether the rate is fixed or adjustable, summarizes the estimated loan costs, calculates how much money the borrower will need to take to the closing table and contains loan-comparison calculations that encourage borrowers to apply at more than one lender and compare loan offers.
Three days before closing, the lender is required to deliver the closing disclosure, or CD. This document itemizes the loan costs. The CD is designed to make it fairly easy to compare with the LE, so borrowers can see if the lender changed any terms of the mortgage.
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 percent of income, and don’t want all debt payments (house, auto, credit cards, student loan) to exceed 36 percent 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 percent often get lower interest rates because lenders view such loans 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 Loan Estimate within three days of applying for a loan, as well as the Closing Disclosure three days before closing.
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 percent on a home purchase, or when the borrower has less than 20 percent 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 an HELOC will have a variable rate.
VOR, VOM, VOD, VOE and 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 IRS 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.