Glossary of Finance and Economic Terms (N-R)
Please Note: All definitions used in this glossary were derived from the Freddie Mac Seller/Servicer Guide glossary. For specific information governing the use of material presented on this website, see our Terms & Conditions.
Negative Equity. Condition achieved when the market value of a property declines by more than the borrower’s equity position--that is, the sum of the original down payment, any loan principal repayments and house-price appreciation. For example, suppose a borrower puts down $20,000 to buy a home, and the value of the property promptly declines by more than $25,000. The negative equity amounts to $5,000, meaning the borrower would have to pay $5,000 out-of-pocket to immediately refinance into a 0-percent equity loan at a lower interest rate.
No-Closing-Cost Mortgage. Loan that transfers to a lender the borrower’s responsibility to pay the fees associated with executing a mortgage. Fees often can exceed $5,000. This arrangement frees borrowers of the need to bring cash to the closing table when refinancing, rendering obsolete the guidance that interest rates must drop by 2 percentage points before the new loan payments prove sufficient to offset refinancing costs.
Nonconforming Mortgage. Loan in an amount that exceeds the qualification limits for GSE purchase or government insurance or warranty. See jumbo mortgage.
Notional. Dollar amount upon which the cash flows of a derivative are calculated. For example, an interest-rate swap exchanges interest payments; the payments are calculated by multiplying the interest rate by the notional amount.
Off-Balance Sheet. Accounting treatment for an item that generally is described in a disclosure footnote on a firm’s balance sheet. The investment does not count as an on-balance-sheet asset or liability either because the firm cannot quantify its value or because the value is contingent on future events. The item is entered on the balance sheet when its value is later determined.
On-Balance Sheet. Assets and liabilities shown on a firm’s balance sheet to reflect its financial condition. The balance sheet is a summary of financial positions recorded in accordance with accounting conventions.
Optimum Capital. With respect to residential-mortgage finance, the point at which the incremental benefits to society of lower mortgage costs balance the incremental costs to society of lower institutional bankruptcy risk.
Option. Financial agreement giving an investor the right--but not the obligation--to buy (call option) or sell (put option) a good, security or currency at a prearranged price within a specified time period.
Paid-In Capital. Capital received from investors in exchange for stock, as distinguished from capital generated from Retained Earnings Includes common and preferred stock.
Payment Cap. Limit on the amount a loan payment may increase or decrease over the life of an adjustable-rate mortgage..
Personal Cash. As defined by Freddie Mac’s underwriting guidelines, the following loan-applicant funds can count as part of a borrower's down payment: savings, checking account money on deposit, loan proceeds when fully secured by the borrower’s owned assets, proceeds from the sale of owned assets, net proceeds from the trade-in of a prior home, prior rent credit, trust fund disbursements, verifiable cash deposits and pooled funds from extended family members. The value of lots owned by the loan applicant qualifies as well.
Pool Insurance. Credit enhancement that lowers the cost of default insurance for liabilities that are grouped together. The collateral required for each loan can be reduced when loans are part of a pool because the chance of a single loan going into default is higher than the chance of all loans in a pool going into default, assuming the reasons for default are unrelated.
Portfolio Effect. See Diversification Effect.
Pre-Commitment. Experimental approach to capital-adequacy regulation that permits a bank to specify in advance the amount of capital needed to cover its Trading-Book risk exposure over a quarter. If the loss threshold is exceeded, the bank then faces penalties that could range from public disclosures to additional capital requirements or fines.
Preferred Equity. Stock ownership in a firm that gives preferred shareholders a senior claim over common shareholders on the assets of a firm in the event of bankruptcy. A firm must pay preferred dividends, according to a contractually specified schedule at a rate that is either fixed or floating, before it can pay dividends to common shareholders. Shareholders cannot redeem their stock through the firm but can sell the shares privately.
Prefix. Number assigned to a type of mortgage pool that is used to identify the general characteristics of the loans that comprise the group. For example, the prefix "P0" signals that a mortgage security consists of 30-year, single-family, fixed-rate, prepayment-protection mortgages that charge a 2-percent fee for breaking a three-year moratorium on prepayments. A "P2" prefix denotes that the mortgages pooled together differ from the P0 mix only in that the prepayment lockout period is five years and the buyout fee equals six months of interest payments on the remaining balance.
Prepayment. Payoff of the remaining principal balance of a loan occurring prior to the stated maturity date. Also can refer to an amount paid to reduce the principal balance of a loan in excess of the agreed-upon amortization schedule.
Prepayment Risk. Possibility of receiving either full or partial principal payments before they are due. A full prepayment often results from the sale or refinance of a mortgaged property. A partial prepayment typically occurs when a borrower applies additional money toward the reduction of the principal owed on a mortgage. Prepayments also create reinvestment risk, given the possibility that an investor must reinvest the prepaid principal at a lower interest rate than the first investment was paying.
Present Value. Concept used by financial analysts to account for the fact that a dollar today is worth more than a dollar at some point in the future. Calculating the present value of future income involves discounting future payments by an interest rate equal to the opportunity cost of funds. This concept, for example, provides a way to define the borrower savings received from refinancing by adjusting for the fact that the savings will be realized over many years into the future.
Private Mortgage Insurance. Credit enhancement required by a lender, typically on mortgages with down payments of 20 percent or less. Generally the borrower pays a monthly premium to offset the risk of loan losses to the lender or investor in the event the borrower defaults.
Private-Label Issuer. Companies other than Freddie Mac, Fannie Mae and Ginnie Mae that create and sell mortgage-backed securities or other bonds. Private-label mortgage-backed securities frequently are collateralized by loans that are ineligible for purchase by Freddie Mac.
Private-Label Security. In the housing-finance business, a mortgage-backed security or other bond created and sold by a company other than a government-sponsored enterprise. The security frequently is collateralized by loans that are ineligible for purchase by Freddie Mac or Fannie Mae.
Pro Forma Financial Statement. Hypothetical accounting statement that reports a firm’s position as it would appear if an increase in sales or changes in interest rates or some other event were to occur.
Prompt Corrective Action. Early intervention by government supervisors when the financial position of a bank or other regulated entity begins to erode. The goal is to prevent a weakened institution from reaching insolvency.
RAROC (Risk-Adjusted Return on Capital). Capital-allocation model developed and distributed by Bankers Trust Corp. that is used by its corporate customers to calculate the risk capital needed to cover each business line within its portfolio. The model first determines the risk-adjusted return on each asset or activity then assesses the firm’s relative profitability by comparing returns to the capital required.
Real Economy. Economic model that measures how effectively an economy transforms inputs (labor, capital, land) to outputs (goods, services) by expressing the changes in real terms--quantities rather than in dollars. For example, the model measures how many units of an item can be purchased with one hour of labor. This model was developed by 19th century neoclassical economists who believed the amount of money an individual makes is less important than how well the individual can live on the income.
Real Estate Mortgage Investment Conduit (REMIC). Multiclass bond backed by a pool of mortgage securities or mortgage loans. Similar to a collateralized mortgage obligation (CMO), a REMIC offers certain tax advantages to the security issuer. The terms CMO and REMIC often are used interchangeably.
Real Estate Settlement Procedures Act (RESPA). 1974 law requiring mortgage lenders to provide borrowers with advance disclosures regarding loan settlement costs and charges as well as information about the settlement itself. RESPA prohibits fees for referring settlement business.
Real Terms. Price changes expressed in constant purchasing-power dollars. The value of an object, such as a home, is measured relative to the value of a fixed bundle of goods and services, thus removing the contribution of inflation and isolating the real price change.
Receiver (Receivership). Entity designated to liquidate the assets of a firm that has been declared insolvent. With respect to federally insured financial institutions, the Federal Deposit Insurance Corp. typically assumes this role in an effort to recoup money paid out of the insurance fund to the bankrupt firm’s depositors.
Recession. Downturn in the output of an economy. In the U.S., the length of a recession is measured from the start of two consecutive quarters of negative economic growth and concludes with two consecutive quarters of positive growth.
Recourse. In mortgage finance, a contingent liability (typically recorded as an off-balance-sheet obligation) arising when a lender or investor sells a loan but remains responsible for the payment of any outstanding debt in the event of its default. By contrast, a mortgage sold without recourse means the new holder bears the default risk.
Reference Note.SM Freddie Mac-issued, AAA-rated bond introduced in April 1998. The instrument, representing Freddie Mac corporate debt, is geared toward investors needing an easily tradable, large-denomination alternative issued at regular monthly intervals when shortages of U.S. Treasury notes and bonds occur.
Refinancing Incentive. Financial benefit obtained by a borrower from refinancing an existing mortgage. Measured as the savings gained from trading an existing mortgage for a new mortgage with a lower interest rate.
Regression Analysis. Statistical technique commonly used to summarize the effects that one or more independent or explanatory variables have on a particular dependent variable. For example, regression analysis can estimate the impact of an additional dollar of house-price appreciation on the size of a new mortgage obtained by households that refinance.
REO (Real-Estate Owned). Residential property acquired by the investor through a foreclosure in satisfaction of a mortgage debt that is then held in the investors' inventory of foreclosure homes until sold.
Repeat-Mortgage Transaction. Refers to a property for which Freddie Mac has funded at least two loans over time for either acquisition or refinancing purposes. Freddie Mac maintains a loan-level database of these transactions that includes information about the terms of the old and new mortgages and the amount of appreciation on the property since the origination of the old mortgage.
Reserves. Cash-equivalent assets available to a borrower at settlement after all closing funds are deducted. One month’s reserves is equal to one monthly mortgage payment. Reserves generally must be verified as a condition of obtaining a home loan.
Risk-Adjusted Performance Measure (RAPM). Method for evaluating a firm’s optimal performance level, meaning the greatest expected return for a given level of risk or, equivalently, the lowest risk for a given expected return. A RAPM consists of the firm’s risk-adjusted return (revenues less expenses less reserves allocated to cover expected losses) divided by risk-adjusted capital (capital required to support unexpected default, interest-rate or market losses less capital released by correlations among the risk factors).
Risk-Based Capital Standard (Risk-Based Capital Rule). Capital-adequacy rules predicated on the international Basle Accord, which stipulates that capital levels must equal a proportion of risk-weighted assets, as opposed to unadjusted total assets. Also can refer, in a general sense, to capital levels that have been adjusted for risk.
Risk-Based Pricing. Method of pricing mortgages that charges different fees for loans based on differences in anticipated default costs. An interest rate set through risk-based pricing will vary by the risk-pricing expertise, business volume and administrative efficiency of the lender offering the mortgage.
Rural Housing Service. Program within the U.S. Department of Agriculture that insures and guarantees mortgages on residences located primarily in rural areas and owned by low- and moderate-income borrowers. It is the successor to the Farmers’ Home Administration loan program.