If you are serious about real estate investing, you need to know the basic “lingo” spoken by other investors. Nothing is worse than having a conversation with someone you want to impress when you realize you haven’t understood a word they’ve said in the last 30 minutes.
To help you be better prepared as you network with others and try to grow your real estate holding, we’ve put together a handful of common terms that most investors should know.
The following list is comprised of terms you may encounter as you talk with other real estate investors and related professionals (bankers, escrow and title officers, agents, lawyers, etc.) on a regular basis. Understanding these terms will help you better understand and converse in the real real estate world.
We’ll begin in the middle of the alphabet with “M” words, such as “mortgages.” Mortgages always seem to be a hot topic.
Mortgage: is a lien on the property that secures the Promise to repay a loan. A loan to finance the purchase of real estate, usually with specified payment periods and interest rates.
Mortgage broker: Is a professional who works for a firm that originates and processes loans for a number of lenders.
Mortgage banker: Is a company that originates loans and resells them to secondary mortgage lenders such as:Fannie Mae or Freddie Mac.”Who????”, you ask. Just, read on.
Fannie Mae: Is a sort of acronym which stands for Federal National Mortgage Association (FNMA); a federally-chartered enterprise owned by private stockholders. This enterprise purchases residential mortgages and converts them into securities for sale to investors; by purchasing mortgages, Fannie Mae supplies funds that lenders may loan to potential home buyers.
Freddie Mac: Is another acronym of sorts is the Federal Home Loan Mortgage Corporation (FHLM); a federally-chartered corporation that purchases residential mortgages, coverts them into securities,and sells them to investors, providing lenders with funds for new home buyers.
Mortgage insurance: Is a policy that protects lenders against some or most of the losses that can occur when a borrower defaults on a mortgage loan. Mortgage insurance is required primarily for borrowers with a down payment of less than 20% of the home’s purchase price.
ARM: Adjustable Rate Mortgage is a mortgage loan subject to changes in interest rates. When rates adjust, ARM monthly payments increase or decrease at intervals determined by the lender. The change in monthly payment amount, however, is usually subject to a Cap. “What is Cap in this case?”, you ponder. Again, just read on…
Assumable mortgage: Is a mortgage that can be transferred from a seller to a buyer; once the loan is assumed by the buyer the seller is no longer responsible for repaying it; there may be a fee and/or a credit package involved in the transfer of an assumable mortgage.
Amortization: Is the repayment of a mortgage loan through monthly installments of principal and interest. The monthly payment amount is based on a schedule that will allow you to own your home at the end of a specific time period.
Appraisal: Is a document that gives an estimate of a property’s fair market value; an appraisal is generally required by a lender before loan approval to ensure that the mortgage loan amount is not more than the value of the property.
Assessment: This is a term used to determine the real estate taxes on a property, usually conducted by the County Assessor’s Office.
Balloon Mortgage: Is a mortgage that typically offers low rates for an initial period of time, after the said time period elapses, the balance is due or is refinanced by the borrower.
Bankruptcy: Is a federal law whereby a person’s assets are turned over to a trustee and used to pay off outstanding debts. This typically occurs when someone owes more than they have the ability to repay.
Building code: Is based on a set of agreed upon safety standards within a specific area. A building code is a regulation that determines the design,construction, and materials used in building.
Broker: A broker is an individual or firm that charges a fee or commission for executing buy and sell orders submitted by an investor. A real estate broker has continued his or her education past the real estate agent level and passed the real estate broker’s license. Real estate brokers can work as independent real estate agents or have other agents working for them. The biggest distinction between an agent, Realtor and a broker is that a broker can work on his or her own, while an agent or associate has to work under a licensed broker.
Cap: Is a limit, such as that placed on an adjustable rate mortgage, on how much a monthly payment or interest rate can increase or decrease.
Cap Ex or Capital Expenditures: Are funds used to acquire or upgrade physical assets such as property, industrial buildings or equipment. Larger expenses, like roofs, mechanicals (plumbing and electrical), that are considered to be a contribution to the long term value of the property are called “capital expenses.”
Cap Rate: The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment.
Cash Flow: On the Old Dawg’s REI Network we like to say “Cash Flow is King.” Cash flow is the lifeblood of your investment. Cash flow can be calculated at the simplest levels by the following equation: Cash Flow = Revenue – Expenses. We also call it your “take home” pay or your true profits after all expenses, including PITI.
Cash-on-Cash Return: Cash-on-cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. For example, when an investor purchases a rental property, she might put down only 10% for a cash down payment. Cash-on-cash return measures the annual return the investor made on the property in relation to the down payment only.
Credit Bureau Score: a number representing the likelihood a borrower may default. This number is based upon credit history and is used to determine ability to qualify for a mortgage loan.
DSCR: The debt service coverage ratio (DSCR), also known as “debt coverage ratio” (DCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity’s (person or corporation) ability to produce enough cash to cover its debt (including lease) payments.
Debt-to-Income Ratio: a comparison of gross income to housing and non-housing expenses. With the FHA, the-monthly mortgage payment should be no more than 29% of monthly gross income (before taxes) and the mortgage payment combined with non-housing debts should not exceed 41% of income.
Debt Service: This is a fancy way to say “mortgage payment.” It’s the money required to “Service the Debt” on the property. It includes the interest on the loan and any pay back of the loan balance (principal reduction, defined below). The NOI minus the Debt Service equals your cash flow.
Doors or Units: It refers to the rentable living areas or rental entities of a real estate investment. For example, a 12-unit apartment is said to have 12 doors. Three single family homes are said to also be 3 units or 3 doors.
EEM: Is short for an Energy Efficient Mortgage. This is an FHA program that helps home buyers save money on utility bills by enabling them to finance the cost of adding energy efficiency features to a new or existing home as part of the home purchase
Equity: The difference between the market value and unpaid mortgage balance on a property.
Fair Housing Act: Is a law that prohibits discrimination in all facets of the home buying process on the basis of race, color, national origin, religion, sex, familial status, or disability.
Gross Rent Multiplier or GRM: the ratio of the price of a real estate investment to its annual rental income before accounting for expenses such as property taxes, insurance, utilities, etc. The number of years the property would take to pay for itself in gross received rent. For the investor looking to purchase, a higher GRM (perhaps over 12) is a poorer opportunity, whereas a lower one (perhaps under 8) is better.
Home Inspection: Is an examination of the structure and mechanical systems to determine a home’s safety; makes the potential home buyer aware of any repairs that may be needed.
IRR or Internal Rate of Return: The rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth.
Interest rate: Is the amount of interest charged on a monthly loan payment. This is usually expressed as a percentage.
LTV or Loan-to-Value: ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. The term is commonly used by banks and building societies to represent the ratio of the first mortgage line as a percentage of the total appraised value of real property. For example, a borrower taking on a $92,500 mortgage to purchase a home appraised at $100,000 would have an LTV ratio of 92.50% (92,500/100,000).
Lease Purchase or Lease Option: This exits to assist low- to moderate-income home buyers in purchasing a home. It allows them to lease a home with an option to buy. The rent payment is made up of the monthly rental payment plus an additional amount that is credited to an account for use as a down payment.
Lien: Is a legal claim against property that must be satisfied When the property is sold
PITI: Stands for Principal, Interest, Taxes, and Insurance. These are the four elements of a monthly mortgage payment. The payments of principal and interest go directly towards repaying the loan while the portion that covers taxes and insurance goes into an escrow account to cover the fees when they are due.
Phase 1 Study: A study to determine the potential environmental hazards that exist on a property.
Pre-qualify: This is when a lender informally determines the maximum amount an individual is eligible to borrow.
Pre-payment: This is a payment of the mortgage loan before the scheduled due date; maybe Subject to a prepayment penalty.
Principal: The amount borrowed from a lender. The principal doesn’t include interest or additional fees.
REO (Real Estate Owned): Property that was foreclosed on by a bank that held a mortgage on the property or a tax lien holder that foreclosed.
Real estate agent: Is an individual who is licensed to negotiate and arrange real estate sales; works for a real estate broker.
REALTOR ®: Is a real estate agent or broker who is a member of the NATIONAL ASSOCIATIONOF REALTORS, and its local and state associations.
Refinancing or Re-Fi: Means paying off one loan by obtaining another. refinancing is generally done to secure better loan terms such as a lower interest rate on a loan.
Rehabilitation mortgage: Is a mortgage that covers the costs of rehabilitating (repairing or Improving) a property. Some rehabilitation mortgages, allow a borrower to roll the costs of rehabilitation and home purchase into one mortgage loan.
Rent to Value: The ratio of rental income to the price of the property. This ratio takes the annual amount of rent received divided by the price paid for the property. As an example, if a property is purchased for $100,000 and the monthly rent is $500 ($6,000 annually), then the rent to value ratio is 6%
Return on Investment (ROI): A performance measurement used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. ROI measures the amount of return on an investment relative to the investment’s cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment, and the result is expressed as a percentage or a ratio.
Short Sale: A sale of real estate in which the proceeds from selling the property is less than the amount owed.
Sweat equity: Using your own labor to build or improve a property as part of the down payment
Title Insurance: This is insurance that protects the lender against any claims that arise from arguments about ownership of the property;also available for home buyers.
Title Search: A check of public records to be sure that the seller is the recognized owner of the real estate and that there are no unsettled liens or other claims against the property.
Of course, there are many more terms and different types of mortgage situations to explore and educate yourself on. But, the above definitions are a good start toward becoming acquainted with the language, lingo and important concepts in real estate.
So the bottom line on real estate lingo is ASK. Don’t let someone throw out a term when you are evaluating a deal and not ask what they mean by it. There’s nothing wrong with getting more clarity and making sure that you are talking about the same thing.
Bill Manassero is the founder/top dog at “The Old Dawg’s REI Network,” a blog, newsletter and podcast for seniors and retirees that teaches the art of real estate investing. His personal real estate investing goal, which will be chronicled at olddawgsreinetwork.com, is to own/control 1,000 units/doors in the next 6 years. Prior to that, Bill and his family lived in Haiti as missionaries serving orphaned, abandoned and at risk children for Child Hope International.