If you’re new to the world of mortgage note buying and selling, you may or may not already be familiar with some of the terms on this list. If this is your first time hearing of mortgage notes as investment vehicles, we recommend that you start here with our Guide to Investing in Mortgage Notes. Regardless of your experience, it may be helpful to review and define them in this specific context. The list below contains many (but not all) of the terms you’ll encounter as you continue to learn about investing in mortgage notes. Feel free to bookmark this page so you can return to it again in the future if you have questions or need additional clarification. A What is an amortization schedule? A loan’s amortization schedule outlines the specific repayment schedule that will be followed to pay back the principal and interest of the loan by the end of the loan term. Some loans, such as interest-only loans, are non-amortizing—the principal balance on this type of loan is paid in a lump sum. What is an appraisal? An appraisal is an estimated valuation of a property or other asset, typically for taxation purposes or to determine a selling price. An Appraisal is prepared by a licensed professional with an appraisal designation. A Broker Price Opinion (BPO) can also be used to value a property. Please see Broker Prices Opinion below. What is an appraised value? Appraised value is the valuation of a property as determined by a qualified appraiser. Unlike the fair market value, a property’s appraised value does not account for market conditions or other factors that could influence the price that a buyer is willing to pay. What does appreciate in value mean? When an asset or investment’s value increases, it is said to appreciate. Among the reasons appreciation may occur are increased demand, changes in interest rates, market fluctuation, changes in inflation. What is an asset? An asset is anything you own that has value. Property, stocks, bonds, investments, bank accounts, and automobiles are all considered assets. An asset does not have to generate income to be considered an asset–anything that you possess or own which can be liquidated for cash, such as furniture, jewelry, and electronics, is regarded as an asset. B What is a balloon payment? A balloon payment is a lump sum paid at the end of a non-amortizing loan. Unlike an amortizing loan, balloon payment loans typically do not amortize the entire principal balance. The balloon payment at the end of the loan term generally is at least double the size of the payments made throughout the loan and covers the remaining principal balance. What is bankruptcy? A person or business declares bankruptcy when they cannot pay back their outstanding debt. Chapter 7 and Chapter 13 are the two most common types of consumer bankruptcy. When a debtor files a bankruptcy petition, they are seeking relief from the payments and possible forgiveness of their debts. In a Chapter 7 bankruptcy, a trustee assigned by the federal bankruptcy court liquidates non-exempt assets of the debtor to pay back some of their debts, and the rest of their qualifying debts are discharged. Chapter 13 bankruptcy reorganizes debt so it may be paid off over the course of 3-5 years. In many cases the court orders the payments for a mortgage to be made during the term of the bankruptcy. If the court determines that the borrower will not be able to make the payments it may order the property to be sold to satisfy the debt. At the end of a Chapter 13 repayment plan, qualifying unsecured debts, such as those from credit cards, are discharged. Who is the borrower on mortgage note? The borrower is the person or persons who received the mortgage loan and is responsible for the loan’s repayment. What is a Broker Price Opinion? A Broker Price Opinion (BPO) is prepared by a licensed broker or real estate sales agent who is active in the market of a specific property. They base their estimate of value on recent sales of comparable homes in the market. While a BPO might indicate the same value as an appraisal, it is considered to be somewhat less accurate than a full appraisal. However, BPO’s are quicker to obtain and less expensive than appraisals and are often used. C What are capital gains? Capital gains are the profits an individual earns from selling an asset that has appreciated in value. It’s important to note that capital gains are only realized when the asset has been sold—profits are considered paper, or unrealized gains until an asset is liquidated. What is cash flow? Cash flow is the amount of money flowing into and out of a company or individual’s hands. For example, an individual receives a paycheck (cash in) and pays their mortgage and other monthly bills (cash out). At the end of the month, if they have brought in more than they have spent, they have a positive cash flow. If they have spent more than they received, they have a negative cash flow. What is collateral? Collateral is an asset that is used to secure a loan. For example, when a borrower takes out a mortgage loan to buy a home, the property they are purchasing is the collateral that secures the loan. If the borrower defaults on the loan and is unable to make payments, the lender may foreclose on the property. Similarly, car loans are secured with the purchased automobile as collateral. If the borrower falls behind and cannot get current on their payments, the lender may repossess the vehicle. What is compound interest? Compound interest is interest earned on interest. While that may sound confusing, the concept is powerfully simple. An investor who chooses to reinvest the interest they have earned on an investment is compounding the interest. Consider the basic example of a $5000 investment that earns 5% interest annually. At the end of the first year, the investor has made $250. If they withdraw the interest from their investment account, their initial $5000 investment will once again earn them $250 in interest in the second year. If they leave the interest in the account with their initial investment, however, they will earn interest on $5250 and end the year with $5512.50. In the third year, their principal balance plus interest will reach $5788.13. By reinvesting the interest instead of cashing it out, the investor is able to earn more money on the same principal investment. What is a Contract for Deed? (Or Land Contract) A Contract for Deed’s purpose is the same as a Deed. It identifies the property’s seller(s) and buyer(s) and the terms of the transaction. Under a Deed the property buyer holds title to a property and the bank has a lien on it until the mortgage is repaid in full. Under a Contract for Deed (Land Contract) the bank holds title until the mortgage is repaid and the occupant is awarded title thereafter. Land Contracts are most often used in seller financed properties in the Midwest. D What is a deed? A property deed, or mortgage, is a legal document that transfers ownership of a property. While commonly confused with titles, the terms are not interchangeable. Having the title to a property means that you have ownership of it, while a deed is a legal document that transfers ownership to another. The mortgage lender generates the deed and files it with the county. It details the name or names of the borrowers and provides the address and legal description of the property. Upon fulfillment of the mortgage loan terms, the lien created by the mortgage note is released and the property is owned “free and clear” of the debt. What does deed in lieu of foreclosure mean? Deed in lieu of foreclosure is an agreement that allows some borrowers to avoid foreclosure if they can no longer make their mortgage loan payments. In a deed in lieu of foreclosure agreement, the homeowner transfers their property title to the lender or note holder. In exchange, the borrower is released from their obligation to repay their mortgage loan. As with other foreclosure avoidance options, unless the state or the deed in lieu of foreclosure agreement disallows it, borrowers may be subject to deficiency judgments after the transfer is complete. What does it mean to default on a loan? When a borrower defaults on a loan, they have failed to pay it according to the terms of the loan’s promissory note. The duration that a borrower may be delinquent on a loan varies based on the type and terms of the loan. What does depreciate in value mean? Depreciate may refer to economic depreciation or the accounting method of depreciating assets over their useful life. In terms of investment, economic depreciation occurs when an asset or investment’s value decreases. Downturns in the housing market, over-construction, and natural disasters are all events that might lead to a real estate investment depreciating in value. What is a discounted mortgage note? A discounted mortgage note is a mortgage note offered for a price that is lower than the value than the borrower owes. What is a distressed mortgage note? A distressed mortgage note may also be referred to as a non-performing note. These are notes where the borrower has ceased making payments or has had difficulty making payments. Investors who buy distressed mortgage notes assume a higher level of risk than investors seeking the passive income of performing mortgage note investment. What does diversification mean? Diversification refers to the practice of spreading investment capital across multiple types of assets and investments. It is a risk management strategy intended to lower the risks of individual investments. What are the different types of down payments on a mortgage? Mortgage down payments are the up-front portion of a property’s sale price that a borrower pays, expressed as a percentage. If a buyer purchases a $150,000 home with a down payment of $30,000 and takes out a mortgage loan for the remaining $120,000, they will have made a 20% down payment. Down payments help to offset the risks for mortgage lenders, so borrowers able to make larger down payments typically receive lower interest rates than those whose down payments reflect a smaller percentage of the property’s value. Depending on the lender and the loan’s terms, borrowers who cannot make a down payment of 20% may be required to make PMI (Private Mortgage Insurance) payments to protect the lender, which increase their mortgage payments. Conventional mortgage loans typically require a 20% down payment, but borrowers may make a down payment as low as 3% with PMI. Borrowers approved for an FHA (Federal Housing Administration) loan can make down payments for as little as 3.5% and as much as 10%, depending on other factors such as their credit score. Borrowers who qualify for VA (US Dept of Veteran Affairs) loans or USDA (US Dept of Agriculture) loans may not be required to make a down payment, nor are they required to pay PMI, as the VA and USDA loan programs guarantee a portion of the loan, which mitigate risks for lenders. E What is equity? Equity, in reference to real estate, refers to the difference between a home’s value and the amount owed on their mortgage. For example, a homeowner who has $150,000 remaining on their mortgage and their home’s value is $250,000 has $100,000 of equity in their home. Borrowers may opt to refinance once they have substantial equity in their home to lower their interest rates and payment amounts, pay off their loan faster, or to use the equity they have accrued to pay for other expenses. F What is fair market value? Fair market value (FMV) is an estimation of an asset or property’s value in an open and competitive market. This estimation differs from a property’s appraised value in that it factors in the market as opposed to merely an appraiser’s estimation. Fair market value estimates the likely price a property could be sold for on the open market if both buyer and seller are 1) acting in their own interest, 2) not rushed or pressured to close the sale, and 3) knowledgeable about the property. What is a first position mortgage note? Borrowers are not limited to taking out only one mortgage loan on a property. An owner may choose to take out a second mortgage for many reasons. Since mortgages use the property as collateral, the loan position determines which lender or note holder is given priority if the borrower defaults on their loan or has another lien placed on the property. For example, if a property has a first mortgage and second mortgage, the note holder for either mortgage may initiate foreclosure proceedings if the borrower defaults on their loan. However, the holder of the mortgage note in first position will receive payment first, even if the owner of the note in second position initiates the foreclosure. Only after the first note is satisfied will any claims in second or even third position be paid. What is an FHA loan? FHA loans are one of three different government-backed loan types. The Department of Housing and Urban Development (HUD) manages the FHA loan program, which insures lenders and mitigates some of the risk of the loan should the borrower default. Qualified borrowers may make down payments as low as 3.5% or as much as 10% of the purchase price, depending on other factors on their application, and pay MIP (Mortgage Insurance Premiums) to offset the lender’s risk further. What is a foreclosure? If a borrower fails to make payments on a secured loan, the lending institution may initiate legal foreclosure proceedings to seize the property held as collateral. This is known as involuntary foreclosure. Voluntary foreclosure is a process undertaken by the borrower when they can no longer make payments on their mortgage. Similar to strategic default, these borrowers choose to cease making payments on their mortgage and “walk away” from their home. While voluntary foreclosure and strategic default are terms that may be used interchangeably, often a distinction is made between the two, with voluntary foreclosure applying in instances where the borrower’s ability to pay, not their willingness, drives the decision. G What is a government-insured mortgage? Unlike most conventional home loans, government-insured mortgage loans provide prospective homebuyers with options for low- or no-down payment mortgages in some cases by backing or insuring the loans to mitigate risks for lenders. The three types of government-backed mortgage loans are FHA (Federal Housing Administration) loans, VA (US Dept of Veteran Affairs) loans, and USDA (US Dept of Agriculture) loans. L Who is the lender on a mortgage note? The lender on a mortgage note is the bank, credit union, or individual who is extending the funds detailed in the loan to the borrower. What is a lien? Liens give a person or organization a right or claim to someone else’s property. For example, a mortgage lender files a lien against the property used to secure a mortgage when originating the loan. The lender, as a lienholder, can initiate legal foreclosure proceedings to recoup their costs if the borrower defaults on the loan. What does liquidate an asset mean? Liquidating an asset is, essentially, selling an asset or taking other steps to convert it into cash. The meaning is the same whether the asset is a tangible item, such as an automobile or real estate; or whether it is a paper asset, such as stocks, bonds, and mortgage notes. What is loan modification? Mortgage loan modifications are agreements between borrowers and lenders that change the original terms of a mortgage note, typically to allow borrowers to avoid foreclosure by making their loan payments more affordable. Mortgage loan modifications usually lower the interest rate and extend the term of the loan and may fold any past due balances into future principal payments. What does loan position mean? Loan position refers to the age, or priority, of a loan. On a secured loan, the lender or note holder has a right to recoup their investment if the borrower defaults by taking ownership of the collateral used to secure the loan. If the collateral is securing more than one loan, the position of each loan determines who gets paid first. What is a loan rate? Loan rate refers to the interest rate on a loan and, possibly, the interest accrual method. What is a loan term? Loan term typically refers to the time over which a loan will be repaid. What is loan to value ratio? Loan to value ratio is a calculation to assess the risk of extending a loan or investing in a property or asset. It is calculated by dividing the loan amount by the value of the collateral. For example, a $160,000 mortgage loan secured by a home valued at $200,000 has a loan to value ratio of 80%. M What is a mortgage? A mortgage is a type of secured loan that uses property or real estate as collateral. Mortgages are typically granted by banks, though private lenders do exist, and allow borrowers to repay the principal amount of the loan plus interest over a period that typically spans 10-30 years. A mortgage document, or deed, is generated by the lender and contains the name or names of the borrowers, the address and a description of the property, and details the covenant the borrower and lender are entering. The deed is a legal document that is filed with the county after it is signed. Once the borrower has repaid their mortgage loan in full, the deed is signed to transfer the title, or ownership, to the borrower. What is a mortgage note? A mortgage note, also called a promissory note, is a document produced alongside a mortgage. The note specifies the terms and conditions of the mortgage and includes the address of the property, the name or names of the borrowers, the interest rate and accrual method, the principal loan amount, the loan term, and any additional fees that borrowers may incur. Unlike a mortgage or deed of trust, the mortgage note is not recorded in the county land records. What does a mortgage note broker do? Mortgage note brokers are people who buy mortgage notes for the purpose of selling them to investors, though they often also hold a portfolio of notes themselves. Brokers do the laborious work of finding and assessing notes for buyers, including identifying the level of risk associated with a note and estimating its ROI to match it to the right buyer. What is a mortgage note buyer? Mortgage note buyers are real estate investors who, instead of buying property, buy existing mortgage notes on properties. As the owner of a mortgage note on a property, these investors take the place of the lending institution that originated the loan. When a mortgage note is sold, the borrower continues to make payments on the loan to the new note owner rather than to the originating lender. What is mortgage note investing? Mortgage note investing is a type of real estate investing that can generate long-term, passive income. Investors purchase mortgage notes, typically at a discount, and then take the place of the lender for as long as they hold the note. As the note holder, they have purchased not the property, but the borrower’s future mortgage payments. Many mortgage note investors choose this investment vehicle because it generates consistent, long-term, monthly cash flow without the overhead and energy required by more hands-on real estate investments, such as rental properties. What is a mortgage note seller? A mortgage note seller may be an individual, a large investment firm, or a lending institution, such as a bank or credit union. Originating institutions often bundle and sell mortgage notes to investment firms and brokerage groups. Individual sellers may have offered seller financing on a property, or they may have bought the note from a broker or another note seller and now wish to liquidate the asset. N What is a non-performing mortgage note? A non-performing mortgage note is a note on which the borrower is not paying the loan as agreed, and has either fallen behind on payments, is not making payments for the full amount, or has defaulted on the loan. Non-performing mortgage notes carry a higher risk for investors than performing mortgage notes and require more work and time before an investor might see a return, as well. Investors in non-performing notes may purchase them with intent to foreclose and rent or flip the property, though many also offer loan modifications as an option to help borrowers stay in their homes. O What is the originating institution of a loan? The originator or originating institution of a loan is the original lender–the person or institution who loaned the funds to the borrower initially. P What are paper gains? When an asset appreciates in value, it is considered a paper gain or paper profit up until the point at which it is sold. The terms unrealized gains and unrealized profits are also used to describe assets at this stage. What does passive income mean? Passive income refers to investments and income opportunities that require little ongoing maintenance. Many require an initial upfront investment but need little work to maintain but return consistent earnings once the initial investment or energy is expended. What is a performing mortgage note? A performing mortgage note is a mortgage note on which the borrower is current on the loan and is making payments on time and for the agreed upon amount according to the terms of the loan. What are points on a mortgage? Mortgage points offer borrowers a method to reduce the interest rate on their loan by paying some of the interest up front. Sometimes called “buying down” the rate, the interest rate reduction a borrower receives for buying points will vary from lender to lender. What is prime rate? The prime rate, or prime interest rate, is the rate that US banks extend to their most creditworthy customers. The prime rate is set based on the federal funds target rate and is typically three percentage points higher. What is principal? In investing terms, principal refers to an original sum of money, such as the initial amount put toward an investment or the original amount borrowed on a loan. What is Private Mortgage Insurance (PMI)? Borrowers who take out a conventional mortgage loan with a down payment less than 20% may be required to pay for private mortgage insurance (PMI), which protects the lender should the borrower default. R What are realized gains? Once an asset with appreciated value is sold, its gains are referred to as realized gains or realized profits. It is at this point that it may be considered taxable. Until an asset is sold, any potential gains are referred to as paper, or unrealized, gains. What does it mean to refinance a loan? Borrowers may refinance a home loan to obtain a better rate than they initially qualified for which could reduce their monthly payment amounts or allow them to pay off their mortgage early. They may also refinance to extract some of the equity they have amassed in their home in order to pay for other expenses. What is a re-performing mortgage note? A re-performing mortgage note is one on which the borrower defaulted or fell behind on payments but has since begun paying the loan again either according to its terms or due to a loan modification. What is Return on Investment (ROI)? Return on investment (ROI) refers to the profit generated by an investment. An elementary example would be an investment of $1000 on which you incur no additional costs and earn $500. In this example, your ROI would be 50%. To calculate ROI, you need to subtract your initial investment or starting balance from your ending balance, and then divide the result by your starting balance. Using the example above, this would look like: Ending balance ($1500) – Starting balance ($1000) = $500 500 \/ 1000 = .5 or 50% What does risk mean in investing terms? In financial terms, risk refers to the chances that an investment or transaction will lose money. What is risk capacity? Risk capacity is the amount of risk an investor is capable of enduring. Unlike risk tolerance, risk capacity does not look at what level of risk an investor is comfortable with but, instead, what level of risk an investor is able to accept. What does risk management mean? Risk management includes both analyzing and forecasting how an investment will perform and identifying potential avenues to mitigate risks in line with the capacity and tolerance of the investor What is risk tolerance? Risk tolerance refers to the level of risk an individual investor is willing to endure. Unlike risk capacity, risk tolerance defines an investor’s willingness to tolerate risk but not their ability to withstand it. S What is a second position mortgage note? If a borrower has taken out a second mortgage loan on their property, the second mortgage will be considered a second position mortgage note. The loan position of a note identifies its repayment priority if the borrower is foreclosed upon or declares bankruptcy. Only after the first position loan is repaid are loans in second or even third positions repaid. What is a secured loan? A secured loan is a loan which is secured by collateral to protect the lender. Mortgage loans are secured by the property that the borrower seeks to buy. With the property held as collateral on the loan, the lender or note owner can seek to repossess (or foreclose) on the property, which they may either sell to recoup their investment or maintain as a rental property if they wish. What does seller financing mean? Seller financing, or owner financing, is a loan extended from a property seller to a property buyer in place of a traditional mortgage loan. Seller-financed loans are typically shorter-term than conventional mortgages. A typical agreement may divide equal monthly payments across a five-year term, with a down payment due at the start and a balloon payment due at the end. Ideally, buyers will be able to secure traditional funding by the end of the term to fulfill the agreement. What is a short sale? In real estate, a short sale is the process of selling a home for an amount that is less than what the borrower owes on the mortgage. Lenders may approve a short sale to avoid the foreclosure process. In some states, unless the short sale agreement waives the lender’s right to collect deficient amounts, lenders can seek a deficiency judgment against borrowers after a short sale to recover costs that weren’t covered by the short sale. What is strategic default? When a borrower owes more than their property is worth (also called being “underwater” on a loan), they may choose to default on the loan strategically and walk away from the property, allowing the lender to foreclose. Unlike voluntary foreclosure, strategic default usually refers to borrowers who opt to default on their mortgage and walk away from their home because it has become a bad investment, not necessarily because they can no longer afford to make their payments. In some states, borrowers who strategically default on their mortgage may face deficiency judgments after lenders foreclose on the property. What is a subprime loan? Sub-prime mortgages are extended to some borrowers whose creditworthiness and other criteria exclude them from consideration for traditional mortgages. Because subprime loans present a higher risk for lenders, these loans typically come with interest rates and mortgage structures that mitigate some of the risk. U What is the unpaid balance (UPB) on a mortgage? The unpaid balance, or UPB, is the amount that a borrower currently owes on their loan. On a mortgage note, this would include the total amount they will pay before the loan is satisfied according to its terms but would not include the amount of any missed payments or late fees. The UPB is used to calculate the potential yield of a mortgage note and may also factor into the discount offered on a note by the seller. What is an unsecured loan? Unlike a secured loan, an unsecured loan does not have any collateral attached to it. If the borrower of an unsecured loan defaults the lender cannot seize the collateral to recoup their investment, but they may be able to employ collections attempts or pursue legal action against the borrower, depending on the terms of the loan. What is a USDA loan? USDA mortgage loans are available to qualified buyers through the US Department of Agriculture. The program, which is managed by the Rural Housing Service, is available only for properties in eligible rural areas as determined by the USDA. Borrowers must also meet the USDA income eligibility requirements in order to receive assistance. Approved USDA lenders receive a 90% guarantee on loan notes to offset the risk of approving loans to finance 100% of eligible property sales. V What is a VA Loan? VA loans are offered to military service members and certain members of their family through a US Dept of Veterans Affairs program. The government guarantees VA loans, so lenders can offer up to 100% financing (no down payment) to approved borrowers and will be reimbursed by the VA in the event of default. Y What does yield mean in investing? When referring to investments, yield is the income earned on an investment and is typically given as an annualized percentage relative to its cost. Several factors are considered when calculating the yield of a mortgage note, including the interest rate on the loan, the amortization method, the amount and number of payments, and its purchase price. If you are looking to begin investing in mortgage notes, wish to sell your mortgage note, or want to learn more, we invite you to call us at 510-918-9001 or send us a message through our contact page.