Understand the terms and language used in commercial lending. Find terms and definitions below to help you navigate through HUD, FHA, Fannie Mae, and Freddie Mac debt and loan projects.
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Area Median Income (AMI)
Area Median Income is calculated by the U.S. Department of Urban Development (HUD) in order to determine the eligible income requirements of Federal housing programs.
AMI is calculated by region, looking at the wealthiest households of various sizes down to the poorest, and the income in the middle represents the Area Median Income. When determining eligibility, a family’s income is compared to a percentage of the AMI: < 80% (Low-income), < 50% (Very-Low income), < 30% (Extremely low-income).
Amortization
Amortization is the time period of when a loan is to be paid off. Often times, amortized loan payments include both the amount owed and a portion of the interest. The loan term and the amortization may not always match. Fannie Mae and Freddie Mac offer loan terms of 3, 5, 7, 10, 12, and 15 years amortized over 30 years with the loan balance due at the loan terms maturity date.
Annual Debt Service
The annual debt service is used to tell the lenders and borrowers how much money is needed each year to pay off long term loans. The total amount of money required each year to make payments on the principal and interest on long-term loans, bond interest, and the principals of maturing bonds.
Assumable mortgage
An assumable mortgage is a preexisting mortgage that is taken over by another borrower. All loans provided by the Federal Housing Administration (FHA) are assumable. This means that FHA backed projects can be transferred over to other borrowers.
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Balloon Payment
A balloon payment is a sum of money paid at the end of balloon loans. These loans typically have smaller monthly payments that do not end up sufficiently paying for the loan once it is due. This results in the lump sum (balloon payment) being owned at the end of the loan.
Basis Point
These are units of measure to describe percentage changes. Basis points are 1/100th of 1.00%. For example, 20 base points would be 0.20%. Basis points are a common unit of measurement for interest rates. A basis point is equal to 1/100th of 1%, 0.01%, or .0001. This means that a 1% change is equal to 100 basis points, or 0.01% is equal to 1 basis point. They are used to denote the percentage change in a financial instrument.
Borrower
A Borrower is an individual or entity (public or private) that obtains financial funding from a Lender with the promise to repay those funds under set conditions.
Bridge Loan
A bridge loan is a short-term loan used until a person or company secures permanent financing or removes an existing obligation. It allows the user to meet current obligations by providing immediate cash flow. Bridge loans are short term, up to one year, have relatively higher interest rates, and are usually backed by some form of collateral, such as real estate or inventory.
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CAP (Capitalization) Rate
Capitalization rate (or Cap Rate for short) is commonly used in real estate and refers to the rate of return on a property based on the net operating income (NOI) that the property generates. The capitalization rate is a metric that is used by investors to determine the potential return on investment or payback of capital.
Capital Expenditures
Expenses that include large items that need to be replaced for a project that include roofs, siding, windows, appliances, driveways, HVAC systems, and major remodeling of units.
Capital Gain
Capital gain is a rise in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold.
Cash Sweep
When a borrower is unable to payoff the note when the loan matures and a balloon payment comes due, the lender uses cash flow from the project to pay down the balance.
CMBS (Commercial mortgage-backed securities) Loan
Commercial mortgage-backed securities loans are used for projects that involve companies that need working space such as warehouses, hotels, or multifamily apartments. CMBS (Commercial Mortgage Backed Security) are loans that are pooled into securities and sold on the secondary market to investors.
Contingency Reserve
Contingency reserves are funds that are placed aside to help account for additional costs that were not a part of the original project. This can help developers safeguard themselves from items like additional labor or renovation costs.
Cost Basis
The cost basis is the purchase price, plus certain other expenses. You use the full purchase price that include real estate taxes owed by the seller that you pay, settlement fees and other costs such as title insurance.
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Defeasance
Defeasance is a contract provision that voids a bond or a loan on a balance sheet allowing the borrower to exchange another cash-flowing asset for the collateral.
Discount Rate
Discount rates are used by investors to determine if a project is profitable. By finding out the discount rate, investors can get an idea of how much future earnings are worth in the present.
DSCR (Debt Service Coverage Ratio)
Put simply, a Debt Service Coverage Ratio or DSCR is the available cash flow to pay any current debt obligations. To calculate the DSCR, divide the net operating income (NOI) by the annual debt. This measurement is designed to determine if revenue generated by any given property will be enough to cover a new loan payment by 1.10x.
Due Diligence
Due Diligence is a comprehensive analysis of a project to evaluate the value.
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Exit Fee
An Exit Fee is essentially a prepayment penalty, however, the lender is entitled to the fee when the loan is completely paid off, whether early, on-time, or late.
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Gross Rent Multiplier
A Gross Rent Multiplier (GRM) represents the number of years it will take for the property to pay itself off from the received gross rent acquired. GRM is equal to the price of an investment divided by the annual rental income from the property (before accounting for expenses).
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FHA (Federal Housing Administration)
The Federal Housing Administration (FHA), provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. FHA insures mortgages on single-family homes, multifamily properties, residential care facilities, and hospitals.
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Hard Costs
A Hard Cost is related to the physical development of a construction project. Hard costs include labor, materials, infrastructure, furniture, fixtures and equipment, landscaping, site work, and contingency costs.
HUD (Housing and Urban Development)
The Department of Housing and Urban Development (HUD) is a government agency created in 1965, which was designed to provide access to fair priced housing. HUD overseas the FHA which helps insure mortgage loans to approved lenders. The Department of Housing and Urban Development administers programs that provide housing and community development assistance.
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LEED (Leadership in Energy and Environmental Design) Certified Green Apartments
Leadership in Energy and Environmental Design is a certification that is recognized worldwide. All types of buildings can be LEED certified, but it’s very common for new multifamily projects. Typically, the cost will be much higher for renters, but energy and water usage provides large savings down the line for developers.
Lender
Lenders are banks, mortgage banks, or other financial institutions that issue loans. Lenders process the application, underwrite, and fund your mortgage.
Loan to Cost Ratio
The LTC (Loan to Cost Ratio) of a development is the value of a total loan amount requested from the lender, divided by how much the project is expected to cost. The LTC ratio of a development is then used to calculate the loan amount percentage that a lender is willing to grant a borrower based on the total cost of their project.
Loan to Value Ratio
A loan to value (LTV) ratio compares the size of the loan you're requesting to take out compared to the appraised value of the item you want to buy.
Low Income Housing Tax Credit (LIHTC)
Created during the Tax Reform Act of 1986, a Low Income Housing Tax Credit (LIHTC) is a Federal tax credit available for affordable housing investments and is offered 1 to 1 or dollar to dollar. The goal of an LIHTC is to incentivize the acquisition of private property for the development of affordable housing by lower income Americans. Approximately 90% of the affordable rental housing in the United States today is accounted for by LIHTC.
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Maturity Date
Loan maturity date refers to the date on which a borrower's final loan payment is due. Once that payment is made and all repayment terms have been met, the promissory note that is a record of the original debt is retired. In the case of a secured loan, the lender no longer has a claim to any of the borrower's assets.
Mezzanine Debt
Mezzanine Debt is used to bridge the gap during the construction or purchase of a property until equity financing is put in place.
Mortgage Insurance Premium (MIP)
FHA Mortgage Insurance Premium (MIP), like PMI, is an additional fee you pay to protect the lender’s financial interests in case you default on your loan. FHA borrowers are required to pay two FHA mortgage insurance premiums — upfront at closing, and annually for as long as you repay your FHA loan, in most cases
Multifamily Accelerated Processing (MAP)
Multifamily Accelerated Processing or MAP, is a system rolled-out in 2000 in order to expedite the processing of loan applications for FHA multifamily mortgage insurance. This can include Purchasing, Refinancing, New Construction, or Rehabilitation of multifamily properties.
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Net Operating Income (NOI)
Net Operating Income, of NOI is the amount of income generated and collected by an owned property after all expenses for operations are deducted (NOI = Total Revenue – Operation Expenses).
Non-Recourse
Non-Recourse is a mortgage loan that is secured by collateral and the lender can not come after the borrower personally for any further compensation unless a fraudulent act was involved.
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Occupancy Rate
Occupancy Rate is calculated by dividing the number of rental units occupied by the total number of rental units available.
Open-Ended Construction Loan
An Open-Ended Construction Loan is a type mortgage allowing the borrower to increase the outstanding principal amount at a later date. This allows for borrowers to obtain more funding from the lender.
Operating Expenses
Operating Expenses include any costs associated with maintaining a project or operation of a commercial property. Examples of this include insurance, legal or accounting fees, utilities, etc.
Origination Date
An Origination Date is a date in which a loan is funded. Generally, this will fall on the date of closure on a property and when the mortgage deed is signed.
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Project Capital Needs Assessments (PCNA)
A reporting tool designed to assess a current projects future monetary needs for multifamily properties, a Project Capital Needs Assessment allows investors/lenders to alleviate risk and project expenses over the term.
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Recourse
Recourse allows the lender to go after the borrower’s personal assets in the event of the default of a debt.
Rent Roll
A rent roll reflects a property's current tenants and how much they pay in rent. A rent roll is the best way to determine the true income of an existing commercial property.
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Soft Costs
A Soft Cost is an expense indirectly related to the construction of a property during development. Examples of Soft Costs are marketing, engineering, architectural, third party reports, licensing and regulatory fees. Other costs include developer fees, financing fees, and operating deficit reserves.
Securitization
Most commercial mortgages are securitized. Loans are sold and pooled together that creates a mortgage security traded in capital markets for profit. Securitizations can take many different forms. The most common form are mortgage-backed securities.
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Total Operating Expenses
Total Operating Expenses generally include Insurance, Property Management, Property Taxes, Utilities, Repair and Maintenance, and Administrative Expenses.
Turnover Rate
Apartment turnover rate is the percentage of renters that move out of a property at the end of their leased contract.
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Yield Maintenance
As a prepayment penalty, Yield Maintenance allows lenders/investors to gain a yield as if the borrower had not missed any scheduled interest payments through the maturity date. Yield Maintenance is designed to make refinancing unattractive to borrowers and mitigate a lender’s prepayment risk.
Yield Maintenance is calculated by multiplying the value of remaining payments on the mortgage by the interest rate minus the treasury yield (YM = Remaining Payments X (Interest rate – Treasury Yield).
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