REAL ESTATE TERMS
What is
SMALL
When you’re using a mortgage to buy a home, there’s a good chance your lender will require something called an escrow account. Here’s what escrow means, and what you need to know about this important part of the mortgage process.
What is mortgage escrow?
At the most basic level, there are two kinds of stock: preferred and common. Preferred stock is rarer than common stock, generally comprising a small proportion of all shares. It’s often more expensive, and can come with a minimum purchase amount.
Escrow fraud and scams
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SMALL CAP?
Mortgage escrow accounts are special holding accounts for your property tax payments and homeowners insurance premiums. Typically, you don’t pay these bills from this account, or
SHORT-TERM
CAPITAL GAINS
Profits made from selling assets owned for one year or less.
LONG-TERM
CAPITAL GAINS
Profits made from selling assets owned for more than one year.
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000.
Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket.
Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
EBITDA doesn’t need to be measured by the Securities and Exchange Commission’s accounting standards, the Generally Accepted Accounting Principles (GAAP), so it is not a required line item on a company’s financial statement. EBITDA has become much more common in recent years, although many firms list an adjusted EBITDA figure.
Before the proliferation of
inexpensive computer
technology, it had been very
difficult to create and price
complicated derivative contracts, but this problem was more or less solved by the 1990s, thanks also to the Black-Scholes equation. Mortgage-backed securities became very common investment products. Instead of using derivatives to effectively balance risk, institutional traders began buying them up as ways to create leverage and take on much more risk. When the U.S. housing market began to crumble in 2006 and 2007, MBS investments spread throughout the banking system began to rapidly lose value, precipitating the crisis.
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
When a company issues more shares, the price of an individual share falls. Anti-dilutive preferred stock allows investors to receive more shares of a stock than he original paid for in the event that his are worth less as a result of a dilution.
The measure can be calculated by taking a company’s net income and adding back interest expense, taxes, depreciation, and amortization. Alternatively, it can be calculated by taking a company’s operating profit — EBIT, or earnings before interest and taxes — and adding depreciation and amortization.
Susan opens a credit card with a $1,000 credit limit and an interest rate of 14.99.
She makes a purchase of $200.
Susan understands she will pay interest on the balance until she pays it off, but she decides to carry a revolving balance.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
If shares of Dynaco rise
above $150, the buyer of
the options wins and
Englebert is obligated to
sell 100 shares to the
holder for $150. But if they
never hit the strike price of $150, Englebert wins and gets to keep the $200 premium the buyer paid. If shares of Dynaco get closer to the strike price of $150, the buyer can resell the option and make a profit off his speculative bet, but if shares of Dynaco decline — widening the spread between the strike price and the underlying asset price — the price of the option falls.
$100 million
$2
$20 million
$10 million
– Minus
PRICE PER SHARE
EXPENSES
Equals =
$30 million
NET PROFIT
>$10B
“Escrow” refers to a financial instrument, generally an account, held by a neutral third party on behalf of two parties engaged in a transaction. With an escrow account, the funds are held or managed by a middleman until the transaction is complete or a contract is fulfilled.
Though escrow accounts are commonly used in real estate, they also can be used for any other transactions that require an agreement between a buyer and seller, or require time to inspect what’s being purchased before payment is made.
x
=
$10 Billion
PRICE/SHARE
MARKET CAP VALUE
NOT A LARGE CAP COMPANY
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A LARGE CAP COMPANY
=
63,000,000
$200
$12.6 Billion
Convertible preferred stock can be exchanged for common stock, but not vice versa.
Convertibility:
Anti-dilution:
even deposit money for these bills into it. Instead, your mortgage lender will collect these payments on a monthly basis as part of your mortgage payment, hold them in the account, then pay the bills automatically on your behalf. By holding your property tax and homeowners insurance payments in escrow, your lender ensures that these bills are paid on time, avoiding penalties like late fees or potential liens against your property.
The shareholder has the right to redeem her shares for a predetermined amount called a call price.
Callability:
MORTGAGE
ESCROW?
$300M–$2B
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
Amortization also refers to the practice of spreading out business expenses over the course of years, as opposed to paying them off all at once. This allows the business to soften the blow of expenses by showing one large expense as a series of smaller ones over a period of time.
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A SMALL CAP COMPANY
=
30,000,000
$41
$1.23 Billion
Most ARMs, like the 7/1 ARM, have an initial period during which the interest rate remains fixed, followed by a period during which the lender may periodically adjust the interest rate. Adjustments typically happen every six months or annually, although sometimes rates are adjusted monthly.
The yearly profits from TIPS are considered taxable income by the IRS, even if the TIPS aren’t redeemed. Given the tax implications of TIPS investments, many investors purchase TIPS through mutual funds or deferred retirement accounts.
The S&P 500 index is part of the S&P Global 1200 family of indexes. Other members of the S&P Global 1200 family of indexes include the S&P MidCap 400, which measures the performance of stocks based on 400 midsize companies, and the S&P SmallCap 600, which measures stock performance based on 600 small companies.
Keeping informed about your escrow account is essential, and not just from a budget perspective. Due to the often large amount of money held in escrow, these accounts have become targets for scammers.
5/5 ARM
A 5/5 ARM features a fixed period for five years, with a change allowed every five years after that initial period.
2/28 ARM
The types of scams vary, but one common scheme is duplicating your lender’s or servicer’s website or email communications in an attempt to get your login credentials or have you wire funds to a fraudster. Some scams even set up official-sounding phone numbers as another way to build trust and get you to reveal your login information. Always carefully review any communications relating to your escrow account, and alert your lender or servicer if you suspect fraudulent activity.
How does mortgage escrow work?
The amount of money in the account can change over time, because property tax assessments and insurance premiums fluctuate. If there’s ever a shortfall, your lender will still cover the payment (and then eventually increase your monthly mortgage payment to make up that difference). The lender will send you an escrow analysis annually that identifies whether your account has a shortfall or is overly funded, and how your monthly payment will be adjusted as a result.
Establishing a mortgage escrow account often requires a few months’ worth of property tax payments and premiums upfront at the time of closing.
When do you need an escrow account?
Mortgage escrow accounts —
where your property tax and
homeowners insurance
premiums are paid from — are
often required by lenders.
Typically, you’ll need an escrow
account if your down payment
is less than 20 percent. A mortgage escrow account is required if you’re purchasing with an FHA loan or USDA loan, but not with a VA loan.
Your first encounter with an escrow account, however, will likely be when you deposit earnest money to show the seller you’re serious about purchasing their property. The amount deposited will vary, but typically it’s 1 percent to 2 percent of the purchase price.
You’ll get your deposit back if an inspection reveals major issues with the home, or the appraisal falls short of the agreed-upon sales price and the deal falls through. However, you might not get your earnest money back if you simply change your mind about buying the property.
What is escrow analysis?
Since property taxes and
insurance premiums can
change over time, your
lender will conduct a yearly
review, called an escrow
analysis, to ensure that there are enough funds in your escrow account. The lender will analyze the amount you’ll need to have in your account over the next year, breaking it down by month. From there, your lender will project if you’ll have a shortage or an overage. (In reality, rising property taxes and insurance mean that escrow accounts rarely have an overage.) You’ll be informed of any changes to your account in a statement after the analysis.
What is an escrow cushion?
An escrow cushion is an extra amount above your mortgage payments that your lender or servicer is allowed to collect and hold. The cushion amount can’t exceed two monthly escrow payments. In some states, a cushion may be limited to a smaller amount.
If your cushion is too large at the time of your yearly escrow analysis, the lender or servicer is required to refund that money, or you can put it toward the loan principal on your mortgage.
