Mortgage Industry Terminology

Understanding mortgage industry terminology is essential for MLO exam success and effective communication with borrowers, lenders, and other industry professionals. This section covers key terms across loan mechanics, financial calculations, market operations, and disclosures.

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Loan Terms

Subordination

Subordination is a legal process that changes the priority of liens on a property. When a borrower wants to refinance their first mortgage but has an existing HELOC or second lien, the second lienholder must agree to remain in junior position.

Why Subordination Matters:

• First lien position is critical for loan pricing
• Secondary market investors require first lien position
• Junior lienholders may refuse or require compensation

Lien Priority

Lien priority determines the order in which creditors are paid when a property is sold or foreclosed. Priority is generally determined by recording date.

Example: A property sells for $250,000 in foreclosure with:

• 1st mortgage: $200,000 owed → Receives $200,000
• 2nd mortgage: $60,000 owed → Receives $50,000 (remaining)
• 3rd lien: $20,000 owed → Receives $0

Escrow Accounts

An escrow account (also called impound account) is a savings account managed by the loan servicer to pay property taxes and insurance on behalf of the borrower.

Benefits:

• Ensures taxes and insurance are paid on time
• Prevents lien placement for unpaid taxes
• Spreads large annual costs into monthly payments

Who Requires Escrow:

• FHA loans: Required
• VA loans: Required
• Conventional: Required if LTV > 80% (varies by lender)

Rate Locks

A rate lock is a commitment from the lender to hold a specific interest rate for a set period while the loan is processed.

Key Concepts:

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Financial Terms

Discount Points vs. Origination Points

Both are expressed as a percentage of the loan amount, but serve different purposes:

Discount Points Example:

• Loan amount: $300,000
• 1 discount point = $3,000
• Typical rate reduction: 0.25% per point
• Rate goes from 6.5% to 6.25%

When to Pay Points:

APR vs. Interest Rate

These are often confused but measure different things:

APR Includes:

• Interest rate
• Discount points
• Origination fees
• Mortgage insurance (upfront)
• Most prepaid finance charges

APR Does NOT Include:

• Title insurance
• Appraisal fees
• Credit report fees
• Settlement/closing fees

Example:

Loan A has a lower rate but higher fees, making its APR closer to Loan B's.

Rule: APR is always equal to or higher than the interest rate.

LTV, CLTV, and HCLTV Ratios

These ratios measure loan amounts against property value:

Example Calculation:

• Property value: $400,000
• First mortgage: $320,000
• HELOC limit: $40,000 (balance: $20,000)

DTI (Debt-to-Income) Ratio

DTI compares monthly debt payments to gross monthly income:

What Counts in Back-End DTI:

• Proposed housing payment (PITI)
• Car payments
• Student loans
• Credit card minimums
• Child support/alimony
• Other installment loans

DTI Example:

• Gross monthly income: $8,000
• Proposed PITI: $2,000
• Car payment: $400
• Student loans: $300
• Credit cards: $100

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Market Terms

Primary Market vs. Secondary Market

Primary Market Activities:

• Taking loan applications
• Processing and underwriting
• Closing loans
• Initial funding

Secondary Market Benefits:

• Provides liquidity to lenders
• Allows lenders to make more loans
• Standardizes underwriting guidelines
• Reduces lender risk exposure

Securitization

Securitization is the process of pooling mortgages and selling them as mortgage-backed securities (MBS) to investors.

Benefits of Securitization:

• Lenders get capital to make more loans
• Investors get access to mortgage market
• Borrowers benefit from competitive rates
• Risk is spread across many investors

Fannie Mae, Freddie Mac, and Ginnie Mae

Key Differences:

Why This Matters to MLOs:

• Loan guidelines come from these entities
• Conforming loan limits set by FHFA
• Selling to secondary market requires compliance
• Rate pricing influenced by MBS market

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Disclosure Terms

Yield Spread Premium (Historical)

Yield Spread Premium (YSP) was compensation paid by lenders to brokers for originating loans at above-market rates. This practice was common before 2011.

Current Rules:

• Loan originator compensation cannot vary based on loan terms
• Compensation must be disclosed
• Cannot receive compensation from both borrower and lender

Servicing Transfers

Servicing transfer occurs when the right to collect mortgage payments is sold from one servicer to another.

What Transfers:

• Payment collection
• Escrow account management
• Customer service responsibilities
• Loss mitigation duties

What Does NOT Transfer:

• Loan ownership (may be different entity)
• Loan terms (remain unchanged)
• Borrower obligations

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Key Takeaways

• Subordination allows new first mortgages to take priority over existing junior liens
• Lien priority determines payment order in foreclosure (1st paid first)
• Escrow accounts collect monthly funds for taxes and insurance
• Rate locks protect borrowers from rate increases during processing
• Discount points reduce rates; origination points compensate lenders
• APR is always higher than interest rate because it includes fees
• LTV/CLTV/HCLTV measure different levels of property leverage
• DTI compares debt payments to income (front-end and back-end)
• Primary market is origination; secondary market is where loans are sold
• Securitization converts loan pools into mortgage-backed securities
• Fannie/Freddie buy conventional loans; Ginnie Mae guarantees government MBS

Quick Reference: Essential Mortgage Terms