Review of some banking terms

Hi Real Estate Investors. I remember last year when Ben and I were looking for a bank to loan us money for our investment house, I had no idea what I was doing. I just started calling up banks in Florida and pretended to know what I was talking about.

I wish I had read this article on questions to ask when selecting a lender beforehand. It's a nice overview of questions that you can ask to choose the right bank. Also, articles like this are great because people will leave comments, and sometimes I learn more from the comments than from the article!

To ensure you are updated when new people comment, you'll have to enter a comment yourself. But it can be something as simple as, "Thanks for the info!

Although this article was prepared for US banks, I'm sure a lot of the questions will also apply to Korean banks if you're looking to invest here.

Let me know if you found it helpful. If you have any questions, feel free to send me an email.

Banking terms

Amortization - This refers to the length of time it takes to fully pay back a loan. So if you get a loan that's amortized over 30 years, that means, if you make all the payments, in 30 years, your loan will be paid off.

Term - This refers to how long the bank loan will be 'good for.' For example, if you get a 10 year term, then your loan will be over in 10 years.

Amortization vs Term - Keep in mind that your Amortization schedule and term can differ. Example:

  • Case 1: 30 Year Fully Amortized loan = a loan that will be paid off in 30 years if you make payments. In this case, the loan is amortized over 30 years and the term is also 30 years. After 30 years, you owe the bank nothing!
  • Case 2: 30 Year Amortized loan with a 10 year Term = In Case 2, your payments will be the same as in Case 1. HOWEVER, after 10 years, you will owe whatever the remaining balance on the loan is (since you'll only be about 1/3 of the way of paying it down because it was amortized over 30 years, not 10). Your balance will be due. At this time, most investors will attempt to get a 'new loan' (also known as 'refinancing'), to pay off whatever is still owed.

Why do banks offer an amortization schedule that is longer than the term? The banks do this so that in 10 years, when you refinance your loan, they can charge you a higher interest rate. However, since the amortization is longer, your monthly payments end up being less.

Think of this: If you had to pay back $30 in 30 days, you could pay back $1 / day and be done at the end of 30 days. But if you had to pay back $30 in 10 days, you'd owe $3 each day.

So, the banks are basically saying - You can pay the $1 / day rate (amortization), but after 10 days (term), you still owe me $20, at which point, the bank might offer you another loan with a different interest rate.

As investors, we'll often be dealing with the commercial side of the bank, not the residential side. The commercial side of the bank will rarely give a 30-year fully amortized loan to an investor. Most likely, the bank might offer a product like this:

20-year amortized loan, with a 7 year team

So the loans that most investors want to get are 30-year fully amortized loans at low interest rates (about 4%).

If it's your primary residence, then those types of loans are easier to get, and in some cases, you might be able to put down less than 10% as a down payment.

If it's an investment property, you might be able to get a loan like that but likely you'd have to:

  1. Put the house in your personal name (not an LLC)
  2. Put down a 20% down payment

(Note: If you work with a home builder, a manufactured home provider, or a turnkey specialist, they might have their own in-house financial services and you won't have to deal with an outside bank.)

ARM vs Fixed Rate - ARM stands for Adjustable Rate Mortgage, which means that the interest rate you pay can go up or down on a periodic basis (i.e., every 2, 5, 7, etc. years) based on the prime interest rate at the time (basically, it's related to the rate that the Federal Reserve charges other banks to borrow money).

Fixed Rate Mortgage - The rate stays constant throughout the term of the loan.

Fannie Mae / Freddie Mac - When a bank makes a loan to home buyer, they don't keep the loan on their books. Instead, they sell the loan to a big institutional bank like Fannie Mae or Freddie Mac. Fannie Mae / Freddie Mac are quasi-governmental agencies.

The reason this is done is to encourage banks to give loans by basically guaranteeing the loans. Banks know that the home loan they made to the homebuyer will be the responsibility of Fannie / Freddie, and therefore, they feel more comfortable giving out the loans.

But to get a conforming loan (one that Fannie / Freddie will accept), you often have to follow some strict guidelines (i.e., getting a house appraisal, house is 'live-in' ready, etc).

I hope you find this helpful!

Here's a great resource for helping you understand banking terms. It's helped me a lot in my journey in real estate investing. This is an affiliate link.

The mortgage encyclopedia: The authoritative guide to mortgage programs, practices, prices and pitfalls, Second edition

It's the Kindle version, so please preview it first to make sure it's the type of book you're looking for, before purchasing it. It's really detailed, and when I first started reading it, it was with the purpose of becoming a mortgage broker.

(Banner photo by Romain Vignes, Unsplash)