Adjustable-rate mortgage (ARM) is a loan with an interest rate that adjusts in accordance with a movable economic index.
Balance of Trade Report, which shows the relationship of the U.S. economy with the rest of the world, is released monthly by the Bureau of Economic Analysis. An important economic indicator found in the Balance of Trade Report is the nominal trade deficit.
Bond is a debt instrument. When you buy a bond, you lend someone money at a fixed interest rate for a fixed period of time. While your money is out you receive interest on it. At a specific time in the future, you receive your principal back. Thus, the interest the bond issuer pays you before the bond matures is the return on capital and, when you get your money back, you receive the return of your capital. The bond market is the market for buying and selling bonds.
Capital consists of equity (one’s own money) and debt (borrowed money).
Cash flow is the net income from a property received by an investor after deducting operating expenses and loan payments from gross income. Cash flow is the net spendable dollars remaining after paying all operating expenses.
Compound interest is the interest paid on original principal and on the accrued and unpaid interest that accumulates as the debt matures. It is the interest that interest earns.
Consumer Price Index (CPI) is an index designed to measure the change in price of a fixed market basket of goods and services.
Contraction: as more homes are delivered to the market with less demand, the market contracts and sales growth slows. Eventually, market participants realize that the market has turned down, which causes commitments for new construction to slow down or completely stop. As the contraction phase progresses, the market continues to exhibit high supply and low or negative demand. The extent of the contraction-cycle is determined by the difference between the excess market supply and demand. Market liquidity is low or nonexistent in this phase since the listing-offer spread in property prices is too wide. Property owners quickly realize that they will not be able to sell their properties if they do not lower their asking prices. As a result, the average prices of homes begin to fall in the overall market.
Conventional loan is any loan without government insurance or guarantees. The main sources of conventional loans are commercial banks, thrifts, and mortgage companies.
Debt is a dollar amount that is borrowed from another party, usually under specific terms. It can be secured or unsecured. Secured debt is a debt owed to a creditor that is secured by collateral. Collateral is something of value given as security for a debt. A good example of this is mortgage debt or a car loan. The opposite of secured debt is unsecured debt, which is a debt that is not connected to any specific piece of property. Instead, the creditor may satisfy the debt against the borrower rather than just the collateral.
Deflation is a sustained decrease in the general level of prices—a negative inflation rate. Deflation can cause a severe business downturn; i.e., a recession.
Demand is how much of a product is desired by buyers. Demand may be defined as the ability and willingness to pay various prices for a commodity made available in the market place at varying quantities. In real estate, demand is the amount of a type or style of real estate wanted for purchase or rent in a specific market area for a given period.
Depression may be defined as an economic downturn that is more severe compared to a recession or an economic downturn where real GDP declines by more than 10%.
Down payment is the portion of the purchase price that is not financed.
Econometrics is the application of mathematics and statistics to the study of economic and financial data.
Economics is a social science that studies how governments, firms, and individuals control and allocate scarce resources.
Equity is an owner’s financial interest in real or personal property at a specific moment in time. In real estate, it is the difference between what a property is worth and what the owner owes against that property. At purchase, the equity is equal to the amount of the down payment. If the property is encumbered with a loan, the equity is the difference between the appraised market value of the property and the balance of any outstanding loans.
Expansion: The economy speeds up during expansion and then peaks. During expansions, the economy, measured by indicators like jobs, industrial production, and retail sales, is growing. During an expansion output rises, new construction increases, employment rises, and unemployment falls.
Expansion phase of a real estate market is marked by speculation and expansion of credit, which stimulates the local, regional, and even national economy. Demand continues to increase, creating a need for more properties. As the supply of available property tightens in the marketplace, prices begin to rise rapidly. Expansion continues as long as demand growth rates are higher than supply growth rates. This phase peaks when demand and supply grow at the same rate (reach equilibrium). Before equilibrium, demand grows faster than supply; after equilibrium, supply grows faster than demand.
Federal Housing Administration (FHA) is a federal government agency that insures private home loans for financing homes and/or home repairs.
Finance company is a business that makes consumer loans for which household goods and other personal property serve as collateral. In addition, some private loan companies make home equity loans.
Fiscal policy is the government policy on government spending and taxation.
Gross Domestic Product (GDP) is the total value of goods and services produced within the borders of the United States, regardless of who owns the assets or the nationality of the labor used in producing that output.
Index is a publicly published number that is used as the basis for adjusting the interest rates of adjustable-rate mortgages. The most common indices, or indexes, are the Constant Maturity Treasury (CMT), the 11th District Cost of Funds Index (COFI), the London Interbank Offering Rates (LIBOR), Certificate of Deposit Index (CODI), and the Bank Prime Loan (Prime Rate).
Inflation is defined as a rise in the general level of prices caused by excessive money creation. Inflation reduces the value of money, forcing consumers to spend more money for the same goods and services they were previously able to purchase at lower prices. When general price levels increase, purchasing power falls, and this situation translates into a lower standard of living.
Interest is the charge for the use of money.
Interest-only fixed-rate loans are short-term fixed-rate loans that have fixed monthly payments usually based on a 30-year fully amortizing schedule and a lump sum payment at the end of its term. They typically have terms of 3, 5, and 7 years. The advantage of this type of loan is that the interest rate on balloon loans is generally lower than 30- or 15-year loans, which results in lower monthly payments. The disadvantage is that at the end of the term the borrower must make a lump sum payment to the lender. Additionally, with an interest-only fixed-rate loan, the borrower is not building equity.
Law of demand states that the quantity of goods or services demanded falls as the price rises, and vice versa. Essentially, the higher the price, the lower the quantity demanded. Additionally, consumers tend to substitute in favor of less expensive commodities.
Law of supply states that the quantity of goods or services supplied rises as the market price rises and falls as the price falls. Higher prices give producers an incentive to increase production.
Lender is the person who or company that makes mortgage loans, such as a mortgage banker, credit union, bank, or a savings and loan. A lender underwrites and funds the loan.
Loan-to-value ratio (LTV) is the ratio of the loan amount to the property’s appraised value or selling price, whichever is less.
Maturity date is the date on which a debt becomes due for payment.
Macroeconomics looks at the big picture and is the study of economic systems as a whole, usually on a national basis, but it can be regional or even on an international basis. The study of macroeconomics focuses primarily on national output (measured by gross domestic product (GDP)), unemployment, and inflation.
Microeconomics is the economic theory of the individual or single firm basis. Microeconomics looks at the smaller picture and focuses on the reasoning and choices faced by individual consumers and entrepreneurs in their attempt to allocate recourses as efficiently as possible. Microeconomics focuses on supply and demand and other forces that determine the price levels seen in the economy.
Mixed-use development will combine hotels, light industrial properties, office, residential, and retail areas together.
Money supply, or money stock, is the total amount of money available for transactions and investment in the economy. It consists of currency in circulation, money in checking accounts, deposits in savings, and other liquid assets.
Monetary policy controls the supply of money and influences the cost and availability of credit to promote economic growth, full employment, and price stability. Monetary policy is the regulation of the money supply and interest rates by a central bank to stabilize the economy and control inflation. In the United States, monetary policy is the province of the Federal Reserve System, commonly known as the Fed. By influencing the effective cost of money, the Federal Reserve can affect the amount of money that is available to consumers and businesses.
Mortgage insurance is insurance that provides coverage for the top part of a residential loan in the event of default.
Mortgages and deeds of trust are security instruments. Because mortgages bear interest and give a periodic cash flow to the mortgage owner, there is an informal market for them and they are bought and sold regularly.
Mortgage broker originates loans with the intention of brokering them to lending institutions that have a wholesale loan department. Mortgage brokers are third party originators (TPOs) and not lenders. Mortgage brokers qualify borrowers, take applications, and send completed loan packages to the wholesale lender.
Opportunity cost is the benefit or value of something that must be given up to acquire something else.
Peak of the market occurs when real estate supply growth slowly begins to exceed demand growth. Real estate prices enter a period of stabilization after a period of expansion. At this time, new construction must compete for fewer buyers in the marketplace since the majority of potential buyers have purchased homes or are priced out of the market. Typically, most real estate participants do not recognize when a peak occurs because transactions are at their highest level of activity.
Pension plan is a retirement fund reserved to pay money or benefits to workers upon retirement.
Private individuals are non-fiduciary lenders who offer an alternative source of financing. They participate in financing real estate by carrying back loans on their own property and by investing in security instruments (mortgages and deeds of trust).
Private mortgage insurance (PMI) is extra insurance that lenders require from most homebuyers who obtain conventional loans that are more than 80% of their new home’s value. In other words, buyers with less than a 20% down payment are normally required to buy PMI.
Promissory note (note) is a written legal contract that obligates the borrower to repay a loan.
Purchase money loan. It is used strictly for financing the purchase of real property. Any loan made at the time of a sale, as part of the sale, is a purchase money loan.
Recession is a period when real gross domestic product declines for two consecutive quarters.
Real Estate Cycles: Many economists think that real estate cycles mirror the economy; others think they drive the economy. Cycles are periodic, irregular up and down movements of economic activity that take place over a period of 2 to 6 years. Real estate markets are cyclical due to the relationship between demand and supply for particular types of property. The real estate cycle, just like the business cycle, has two phases and two turning points. The two phases are expansion (recovery or boom) and contraction (recession or bust). The two turning points are peaks and troughs. An expansion is an increase in the pace of economic activity. Conversely, a contraction is a slowdown in the pace of economic activity. The peak is the upper turning point of a business cycle, and the trough is the lower turning point of a business cycle.
Real estate finance provides the flow of money and credit needed to complete transactions for the purchase and/or development of real property.
Real estate investment trust (REIT) is a security that sells like a stock on the major exchanges. REITs invest in real estate or mortgages. REITs were designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks. REITs are subject to a number of special requirements, one of which is that REITs must annually distribute at least 90% of their taxable income in the form of dividends to shareholders. REITs invest in equities, mortgages, or a combination of the two. Equity REITs invest in property. A mortgage REIT, which is also called a real estate mortgage trust (REMT), makes loans on commercial income property. Some REMTs specialize in buying and selling existing real estate loans. Their revenue is derived from the interest earned on the loans. A hybrid or combination REIT purchases equities and makes commercial loans.
Refinancing replaces the old loan with a new one. A person may refinance to reduce the interest rate, lower monthly payments, or change from an adjustable-rate to a fixed-rate loan. The loan amount remains the same, but the terms change. Refinancing usually makes sense only when there has been a drop in interest rates and a person wants a new loan at a lower rate than the existing loan. Refinancing may also benefit those who want to refinance for a longer term to lower monthly payments.
Residential market includes properties that are used as private dwellings and are as diverse as the people who occupy them. Residential properties are usually designed and built as single-family or multi-family residences.
Scarcity. A product must be scarce in order for it to be valuable. Items that are plentiful and free have no economic value.
Stagflation is a period of slow economic growth and relatively high unemployment accompanied by a rise in prices, or inflation.
Supply is how much of the product the market can offer. Supply is the ability and willingness to sell various amounts of a commodity at varying prices, during a given time period. In real estate, supply is the total amount of a given type of property for sale or lease, at various prices, at any given point in time.
Transferability. The ability to transfer ownership to a product is an essential element of value. This only makes sense since the buyer probably wants the item and must be able to take possession. Something that cannot be sold or transferred cannot have a value.
Trough; the real estate market experiences an oversupply of unsold homes, allowing buyers to choose from a wide variety of properties. Sales prices are no longer sharply declining, but maintaining a steady average. The trough gives buyers the best opportunity to purchase real estate, allowing absorption of oversupply to take place. An abundance of alternatives exists for bargain hunters who were unable to purchase a home at the peak or speculators and investors looking to profit in the next real estate cycle.
Unemployment rate is the percentage of the work force that is currently out of work, is unable to find work, but is actively looking for work.
Value is the monetary worth of property, goods, or services to buyers and sellers (the market). The four factors that contribute to value are demand, utility, scarcity, and transferability—DUST for short.
Yield is the return on investment stated as a percentage.
30-year fixed-rate loan offers low monthly payments while providing for a never-changing monthly payment schedule. A typical 30-year, fixed-rate loan takes 22.5 years of level payments to pay half of the original loan amount. 15-year fixed-rate loan is repaid twice as fast because the monthly payment is higher. More money is applied to the principal in the early months of the loan, which cuts the time it takes to reach free and clear ownership.
97% LTV Program allows homebuyers to purchase a single-family home, condo, co-op, or PUD without coming up with a full 5% down payment as previous guidelines mandated.