The limit on how much the interest rate or monthly payment on an
adjustable rate mortgage (ARM) can go up or down.
Most ARMs have several types of interest rate caps:
(1) lifetime caps, which are required by law, that limit the
increase and decrease of a rate over the full course of a loan. A 12% lifetime cap, for example, means the ARM's
rate can never go above 12%, (2) the first adjustment cap, which limits the rate change on the ARM's initial
adjustment and (3) the subsequent adjustment caps (also called periodic caps), which limit the rate changes on the
following adjustment periods, even if the market interest rates significantly rise or fall during this time.
Caps on monthly payments are rare since they can cause negative amortization, a situation where your mortgage
balance increases despite regular monthly payments.
Example: A worse case scenario of an ARM that reaches the maximum cap.
Initial Rate = 6%
Lifetime Cap = +6%
Periodic Cap = +2%
Adjustment Period = annual
Any money that you invest in a business or property.
An example of capital is the money you put towards your
home's down payment or shares of stocks.
See:Capital gain,
Equity
Capital gain
The profit you make when you sell your house.
You can calculate your capital gain by subtracting the adjusted cost basis from your home's selling price.
The adjusted cost basis is your home's purchase price plus any major renovations you have made on your property,
minus any losses like the cost of repairing flood damage. Based on your capital gain, the federal government figures
out how much tax you owe. See:Capital gains tax,
Adjusted cost basis
Capital gains tax
The tax placed on the profit made from selling a home.
The IRS taxes your capital gain, which is the profit you make when you sell your home or other investment.
As long as you have lived in your home for at least 2 of the 5 years prior to sale, you can benefit from the following
capital gains tax breaks: if you are single or widowed, you can pocket the first $250,000 gain tax-free.
If you are married, you take away the first $500,000 without paying any tax. Any profit left over will be taxed at a
20% rate. See:Capital gain
Capital improvement
Any major renovation that increases your property's value.
Some examples of capital improvements include adding a new bedroom, expanding a kitchen,
or upgrading the electrical wiring. Repairs and normal maintenance on a home, such as replacing a broken window or
fixing a hole in the roof do not qualify as capital improvements. See:Adjusted cost basis
Cash-out refinance
When home owners apply for a new, larger loan with the purpose of paying off their present loan and pocketing the
difference. Cash-out refinancing lets you take advantage of the equity that you have built over the years and free up
some cash to remodel your kitchen, pay your children's college tuition or pay off your credit card bills. Usually you
refinance when interest rates are lower than your current loan so you lower your monthly payments. Depending on the
lender, you can get 80%, and in some cases more, of your home's value.
Example: How can you use cash-out refinance to renovate your home?
Susan wants to remodel her entire living room. Her home is worth $200,000 and the mortgage balance is $125,000.
Susan can refinance for $150,000, use $125,000 to pay off her current loan and have $25,000 available to get that
fireplace she always wanted.
See:Refinance Compare: Home equity loan
Cash reserves
Money put aside in case of a financial emergency. Most lenders want to know that you have enough savings, either in a
checking or savings account, a security or even a 401K retirement fund, to provide a cushion for unexpected expenses
in the future. Lenders are typically looking for an amount that is twice your monthly mortgage payment.
Certificate of deposit (CD)
A bank account that earns interest and the depositor agrees not to withdraw money for a set period of time inexchange
for a high interest rate.
The longer that your money remains in a CD, the higher the interest you can earn, which is normally more than a regular
savings or money market account. CD accounts can last typically from 7 days to 3 years and have a minimum deposit of
about $500. Overall, CDs are a safe investment since you are at low risk of losing your initial deposit. See:Down payment
Closing date
The day when a home's sale or purchase is completed. The closing date, agreed upon by both the seller and buyer,
is written in the purchase/sale agreement. Depending on what state the property is located, a closing can either be
an actual meeting that takes place between the buyer and seller, or escrow, which doesn't require a meeting.
Even though what happens at on the closing date varies from state to state, in general, there are 4 main steps:
(1) the buyer pays for the property, including the down payment
and lender fees
(2) the buyer and seller sign the final closing documents
(3) the deed is recorded at the county courthouse
(4) the mortgage officially begins. In some states, these steps span over several days leading up to, and
after, the closing date. See:Settlement,
Escrow
Closing statement
A document that gives a breakdown of the buyer's and seller's closing costs.
A closing statement gives you the final record of the fees paid at closing. In some states, you receive the closing statement on
or after the closing date. If your property closes in escrow, you usually receive the final closing statement in the mail-
normally within 24 hours after the deed of trust is recorded. The lender, broker, escrow agent or attorney can prepare the
closing statement. A closing statement is also called a settlement statement or HUD-1. See:Closing costs
Cloud on title
When a title search finds a claim on a property. Before you buy a house, a title company requires a title search to prove
that the seller really owns the property you are about to buy. It can happen that the search catches a problem or "cloud"
on the title. Some clouds that result from poor record keeping can be easy to clear. But, others, as in the case of
contested wills, can turn into a major problem and take a long time to clear.
Collateral
Something of value that the borrower offers as security on a loan, which the lender can also collect if the loan
isn't repaid. When you buy a home, the property is used as collateral or security for the loan. This is considered a
secured debt, since the lender can sell the property to get back their money in the event you default on the loan. See:Deed of trust,
Mortgage
Collection
When a creditor makes attempts to get the money owed on a debt. If you are past due on your monthly mortgage payments, a
lender will make every effort to collect on the money that you owe. If this fails, the lender will be forced to start the
foreclosure process, and sell your home in order to repay the loan. This happens only .2% of the time, and only a small
percentage of owners lose their property. See:Foreclosure
Community property
Property that is jointly owned by a lawfully married husband and wife. Some states have community property, where each
spouse owns one-half of the property bought during their marriage. In general, both spouses have equal control how the
property is managed, and if one spouse wants to hand over his/her interest to someone else, the other must agree. Also,
either spouse can will their share to anyone they want.Until death do we part takes on new meaning when either spouse
dies without a will-the surviving spouse receives all the property and the children, if any, do not get anything. Any
property that a spouse buys with money that does not come from a community source is considered separate property. Community property states:
Arizona, New Mexico, California, Texas, Idaho, Washington, Louisiana, Wisconsin, Nevada See:Tenancy in common,
Joint tenancy
Comparable sale (comp)
A recent completed sale of a property that is used to estimate the value of a similar property.
Comps come in handy when you're trying to set a property's sale price or you just want an updated value-they provide a
good reference point, so you don't over or under price your home's value. Appraisers, certified professionals who
estimate the fair market value on homes, also use comps to help them evaluate properties.
You should use comps that were sold in the last six months and are similar to your home in age, style, size, condition and
location. You can get comps here, using our Home valuation tool. Real estate agents also have easy access to comps via an
online network. Keep in mind that other factors, such as market conditions also affect a home's selling price. See:Appraisal/Appraiser
Compensating factors
The strengths in a borrower's financial profile that may offset any weaknesses. Lenders carefully study your personal
finances to make sure you are a safe candidate for a loan. Often a lender will overlook a red flag, such as high back
ratio because of compensating factors, such as a high checking account balance or low monthly mortgage payments. Keep
in mind that compensating factors vary from lender to lender. See:Back ratio
Compound interest
Interest due on both the original principal balance and any unpaid interest. Savings accounts often apply compound
interest to the money you deposit. You earn interest on top of interest that you have already gained. So, if you put
$100 in your savings account at 6% annual interest you will earn $6.00 at the end of the year. The next year you will
collect interest on the total amount, $106.00.
Condemnation
When the government uses its power to take private land for public use. The government can use its power to take over
your land, but it must pay you a fair price for the property, as well as the moving costs. The government's right to
condemnation is called eminent domain, which is spelled out in the Fifth Amendment of the U.S. Constitution. Just like
in the movies, condemnation occurs when the government wants to lay down railroad tracks, build highways or construct
public housing. A property can also be condemned because its run down or damaged and dangerous to live in.
Condominium (Condo)
A building or housing development where each person owns his or her unit and shares ownership of the common areas.
Owning a condo is very similar to owning a house, you have a separate deed and mortgage, and pay property taxes on your
unit. The major differences are:
(1) you have a joint ownership of the common areas, including
the land itself, staircases and swimming pool
(2) you have to pay monthly dues to cover maintenance and
repairs for the facilities that you share witheveryone else, such as
garbage collection, lighting in the hallways and landscaping.
Condos also follow a set of strict rules called Covenants, conditions and restrictions, which specify everything from how
maintenance is handled to what color curtains you can or cannot hang on your windows. It is a smart idea to read them
before buying a condo. Also, ask for recent reports that outline future plans for the condo, which might impact your dues. See:Assessment,
Covenants,
conditions and
restrictions Compare: Cooperative
Conforming loan
Loans that meet certain borrowing guidelines and are sold to the secondary market. Conforming loans have a set of standards
for the amount you can borrow and how much you need to put towards a down payment. For example, the ceiling on a conforming
loan for a single-family house is $240,000 in the continental U.S. The cap in Alaska and Hawaii is $360,000.
If you meet these guidelines, you can get lower interest rates and better financing options. If you want to borrow
more you can apply for a non-conforming or jumbo loan.
Lenders make sure that the loans "conform" to these standards so that they can later package groups of conforming loans
to sell to institutions in the secondary market, like the Federal National Mortgage Association (Fannie Mae) to make money
available for new loans. See:Secondary market Compare: Jumbo loan
Construction loan
A loan used to pay for land and for the construction of buildings and/or detached homes. Construction loans normally work
together with take-out loans. First, the land developer gets a construction loan to build a cluster of homes. Then when
all the homes are ready to sell, a buyer gets a take-out loan from a lender to purchase one of the new homes.
The builder uses part or all of the money from the sale towards paying off the construction loan. If you plan to
build your own home, you can also pay off the construction loan using a take-out loan.
Example: How does a builder pay off a construction loan? The builder gets a $1 million construction loan to put up
ten homes.
The builder then puts up each home for sale at $300,000.
The buyer gets a take-out loan for $300,000 to buy one of these brand new homes.
For every home that the builder sells, the builder pays $100,000 towards the construction loan and pockets $200,000 as
profit. See:Blanket mortgage,
Take-out loan
Consumer reporting bureau (agency)
A company that prepares a report of your credit history. The three biggest consumer reporting bureaus are Trans
Union, Experian and Equifax, and each one uses a slightly different model to calculate your credit score. Lenders
will ask the consumer reporting bureau for a copy of your credit report to see if you are a trustworthy candidate for a loan.
Your credit report will outline how much you owe on credit cards, car and student loans, where you have recently applied for
credit and if you've ever had any red flags on your record, like bankruptcy.
Contingency
A clause that allows a buyer or seller to pull out of a contract for a specific reason. Contingencies serve to protect
you against getting stuck in a bad deal or unfavorable situation-think of them as an escape door. Three common
contingencies used by buyers when making an offer are:
(1) a property inspection clause, which says a deal is contingent on an acceptable inspection of the home and grounds
(2) a financing clause that lets you out of a deal if your loan isn't approved and lastly
(3) a clause that gives you an out if the property's appraised value falls short of
the selling price. Sellers often include a contingency clause inthe contract giving the buyer a deadline to get an
approval on a loan.
Contract of sale
A type of financing where a seller legally owns a property until the buyer repays the loan.
Contracts of sale are a creative way for buyers to purchase a home without having to qualify for a loan or to pay
closing costs. The contract is made between the buyer and seller with the lender's approval.
Here's how it works:
(1) the seller holds onto the existing mortgage
(2) the seller names the property's selling price
(3) the seller offers the buyer a loan at a higher interest rate than the existing mortgage
(4) the buyer pays the seller a fixed monthly amount
(5) the seller uses part of this money towards the existing loan and then pockets the difference
(6) the seller hands over the contract on the home when the buyer is paid up.
The buyer can sell or refinance the property, even though the seller holds legal title (ownership) of the property. This
arrangement is commonly called an installment sales contract or agreement of sale. Compare:Wraparound mortgage
Conventional mortgage
Any loan granted by a non-governmental (usually commercial) lender. Most loans are conventional, except for those
insured by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). See:FHA mortgage,
VA loan
Convertible ARM
An adjustable rate mortgage (ARM) that can be switched to a fixed rate mortgage during a specific period. Some lenders
offer convertible ARMs so that you can switch to a fixed rate mortgage in the event interest rates get low enough
that you want to keep the lower rate for the life of the loan. The rules vary from lender to lender, but often you need
to make the change between the first and fifth year of the loan. You should note that your initial interest rate will be
higher than a normal ARM, and to convert, you will have to pay a fee that generally runs between $250 and $500. Each lender
uses a different formula to calculate the converted fixed rate, which is also often higher than overall market rates. See:Adjustable rate mortgage
Cooperative (co-op)
A housing complex or building where you become a shareholder in the corporation that owns the property.
Co-ops are usually found in big cities like New York and Chicago. Unlike a house or condominium, when you buy a co-op,
you will get a stock certificate that shows how many shares you have in the corporation. So, you become a tenant, as well
as a co-owner of the building. The more shares you own, which is based on the unit's size, the more voting power you have
in deciding how the co-op is run. You also pay monthly fees to cover your portion of the building's property taxes and
mortgage, and the costs of repairs and improvements for the common areas, such as the grounds and the elevator.
Before buying a co-op be aware that:
(1) since the tenants depend on each other financially, the building's board of
directors tend to be extremely finicky about new buyers and
(2) getting a mortgage can be difficult since lenders don't
always accept stock shares as security for a loan.
Cost of funds index (COFI)
An economic indicator that lenders use to set an adjustable rate mortgage's interest rate. COFI is one of the more stable
indices that lenders use when setting the interest rate on an adjustable rate mortgage (ARM). Interest rates that are based
on COFI usually move up and down slowly, which can be an advantage when interest rates are predicted to rocket up.
COFI, itself, is the average interest rate that banks in certain states have paid to their customers in recent months.
The 11th District COFI, for example, covers banks in California, Arizona and Nevada. See:Index,
Adjustable rate mortgage
Covenants, conditions and restrictions (CC&R's)
Regulations that maintain a property's design and maintenance. Housing complexes like condominiums have a strict set of
CC&R's that detail how maintenance and repairs are handled, and regulate what physical changes you can and cannot make
to your unit. These rules can cover everything from what color you paint your front door to whether or not you can rent the
unit. Single family homes also have CC&R's that may, for example, ban you from converting your garage into a bedroom.
Since CC&R's can be very specific, it is a very good idea to read them before buying. See:Condominium
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