Real Estate Investing: Financing Terms for Beginners
Securing the financing for the first property is often what makes newbie investors give up on their real estate plans. Getting pre-approved for a mortgage and handling all the paperwork seems like an intimidating and never-ending task that many would like to avoid. However, as soon as you do it once, doing it the second and the third time will be much easier.
All you have to do is put in the time and work to get it right once and the rest will be smooth sailing. With that said, we will review the top 10 terms you need to understand when going through the pre-approval process for a loan. It is important to understand these terms when working with lenders so you don’t overlook important information or miss out on great opportunities.
#1 Amortization
Amortization is the time it takes to pay off the principal balance of the mortgage, usually by a combination of equal periodic payments and extra payments of principal at irregular intervals. Usually associated with a target period (the standard being 25 years) over which the initial blended payment is calculated. The maximum amortization available in Canada is 35 years.
#2 Closing:
Closing refers to the final exchange of consideration and legal completion of a transaction, involving either a house purchase, a mortgage registration, or both.
#3 Down payment
A down payment is the amount of cash paid towards the purchase transaction by the buyer of a home. This is also known as the purchaser’s initial equity in the property, but is used by a lender to judge the personal commitment to the property. For example, a lender considers that, if a buyer saved the down payment, or received it as a gift from a loved one, they will be far more committed to maintaining the property value and making the mortgage payments than if they acquired it for no money down.
#4 Equity
Equity is the difference between the value for which you could sell your property and what is owed against it. There is an important distinction from down payment to a lender. For example, if a buyer purchases a home without a down payment, he/ she can have equity if the value of the property quickly goes up.
#5 Lien:
This is a claim made against a property for the payment of a debt or obligation related to the property or its owners.
#6 Loan-to-value ratio
This refers to the percentage of the value of the property for which a mortgage is required. This ratio is important in determining whether or not default insurance is required, and if so, what the cost of that insurance will be. For example, if the property value is $200,000, the down payment available is $20,000 and the required mortgage is $180,000. The LTV is $180,000 / $200,000 or 90%.
#7 Principal
The amount of money owing on your mortgage, including accrued unpaid interest.
#8 Interest
The amount of money a lender or financial institution receives for lending out money.
#9 Underwriting
The process of deciding whether or not to lend you money (or how much to lend you) based on all the information you have given the lender. Every lender has a different underwriting process and lending criteria which differ to some (usually small) extent from other lenders.
#10 Refinance
Obtaining a new mortgage on an existing property. You might be looking for more money, a better rate, or different prepayment terms. The maximum amount you can refinance your mortgage is 80% of current appraised value. If you break a variable rate term, the bank will charge you a fee which is equivalent to 3 months of interest.