Any new venture is an education and real estate is no exception. Whether you’re a buyer, seller or new investor, real estate terms can need some explaining.
Here’s a shortlist of the most common terms and acronyms used in the real estate industry.
- Amortization – When you pay back your mortgage, some of the money you pay goes towards principal and a smaller amount towards interest. Your mortgage is amortized! As the years go by, the principal side goes up and the interest side comes down. To see the concept visually illustrated, do a Google search for “Amortization Charts.”
- LTV or Loan to Value – Your loan is based on a percentage of the property’s value. What you need to know is what value forms the basis. Banks and loan companies will use an appraiser. When using a private lender, you could jointly agree on a value based on other sales in the market – known as Comparable Sales or “Comps.”
- Net operating income – NOI – is a formula used to evaluate real estate investments that produce income. Net operating income equals all revenue from the property minus all realistically required operating costs.
- The Capitalization Rate – CAP rate – is calculated by NOI divided by the sell price or value of a piece of real estate, usually expressed as a percentage. The CAP Rate is what your return on investment would be, should you own the property free and clear.
- Equity – This is a common real estate term referring to the amount of down payment you put on a property. It’s also used to separate the amount owed on the property in relation to its current value. The owners’ money that’s been paid into the house by down payment or a reduction in principal on the mortgage over time.
- Contingencies – Anything that has to be done before you can move forward with the purchase. Common contingencies deal with the inspection, mortgage, appraisal and time frame. This is done for the protection of both buyer and seller to keep the deal continually moving forward.
- Proof of funds – Any offer made has to prove where the money is coming from. With cash offers, sellers will ask for a proof of funds letter – a declaration from your account holder confirming that you have enough in the account to continue with the offer.
- Carrying costs – If you are rehabbing a property, one of the hidden expenses are the carrying costs. These expenses are not the cost of the rehab but are incurred from the time you take ownership until you rehab and sell the property. Carrying costs are usually interest repayment, taxes, insurance, utilities, etc.
- MLS – an acronym for a multiple listing service. This is the directory where local real estate agents find new listings. Any new property listed by a real estate agent goes to the MLS. This includes any bank owned property, short sales and foreclosures.
- Exit strategy – an important real estate term that means figuring out your end goal before you actually get going; your plan for what you want to do with the property. With a rehab, this is where and how you will sell the property. For a buy and hold property, it’s working out rental price and how to market it.
- Closing costs – are the amount you pay to secure your loan. Closing costs are different from prepaid items. Closing costs are fees to your lender, attorney, title search, title insurance and real estate agent. Prepaid items also paid at closing, are used to prepay your property taxes and insurance.
- Appraisal – not to be confused with the inspection. The appraisal is an independent, subjective view of the value of the property. The inspection is done for the buyers benefit to verify the quality of the property. The appraisal is done for the lender to validate the property value. They not only look at the condition of the property, but also local comparable sales and past listings.
- Real Estate Owned – REO – This term is used for property that was foreclosed on by the bank that held the mortgage or foreclosed on by a tax lien holder. These types of owner have no emotional connection to the property and have not seen its condition.
- Short Sale – When a property sells for less than what is owed to the lenders holding liens on it. The lenders must agree to the sell price and have to issue a “Settlement Letter” giving their consent to release their lien for an amount other than what is owed to them. Short sales take time to work through the red tape with the banks and are usually organized by a third party.
These are just 14 of the many real estate terms that may be confusing and are used every day. Don’t be afraid to ask if you’re not sure what someone is saying; everyone had to start somewhere.