Basic Terms for Real Estate Investing
If you are interested in buying, selling or investing in real estate it is important to understand what you are talking about and the associated terminology. There was a commercial on T.V. recently that showed two little boys with flashlights looking for “equity” because they heard their father say that there was equity hidden in their house that could be used as leverage. The little boys had no idea what equity or leverage were—do you?
Below is a list of commonly used terms associated with the buying and selling of real estate properties. Hopefully this will help you better understand the terminology and will help create a smooth process for your real estate transactions.
Cash Flow – Cash Flow is essentially the difference between your income and your expenses on a property, which can be either a negative or positive figure. Obviously, it is better to have a positive cash flow.
Appreciation – Appreciation represents the increase in the value of a property. There are two types of appreciation. There is appreciation from economic conditions which are beyond your control, such as inflation. As a note, you will not gain significantly from appreciation gained from economic conditions, because the gain is usually offset by a higher cost of living amount. Alternately, market appreciation is something that you can control. Market appreciation is when you purchase a property and improve it (through renovations and upgrades) to force a higher property value.
Leverage – Leverage is when you have the ability to borrow a percentage of the value of a piece of property. Basically, you use the borrowed money to increase your profits in your real estate investment. In real estate investing, leverage presents people with the opportunity to purchase real estate with little, if any, of their own money. You are essentially using other people’s money towards your real estate purchase. Real estate offers a high degree of leverage when compared with other investments.
Amortization – Amortization is a defined as the gradual reduction of a loan debt through periodic installment payments of principal and interest. It is the process of paying off a debt, together with interest, usually in equal payments at regular intervals over a period of time. The outstanding balance associated with your mortgage is reduced with every payment made, and part of the payment is applied first to the interest, and then to pay off the principal amount. The reduction of the principal is called amortization. An amortized loan refers to payment of both principal and interest as opposed to just paying off the interest on a loan.
Escrow – These are funds usually set aside and held in trust for payment of taxes and insurance on a real estate property, or deposits held pending on the closing of the real estate transaction. The funds (money, property, deed or bond) are put into the custody of a third party for delivery to the grantee only after the fulfillment of conditions set out in an agreement.
Appraised Value – The appraised value of a property is an evaluation of a property's worth based on an appraisal performed by a professional appraiser at a given point in time for the process of obtaining a mortgage. The appraisal is typically paid for by the borrower, but the appraiser is usually chosen by the lender.
Assessed Value – The assessed value is the dollar value assigned to a property for the purposes of tax assessment.
Title – Title is the recognition of the legal ownership of a property.
Assumable Mortgage – An assumable mortgage is a type of financing where the outstanding mortgage on a property and its terms are transferred from the current owner to the buyer. The buyer assuming the previous owner's remaining debt does not have to obtain his or her own mortgage. This can be attractive to a buyer when interest rates are on the rise as the previous owner’s interest rates were generally created when interest was at a lower rate. An assumable mortgage is generally obtained through an assumption clause.
Capital Improvement – This is when a property’s overall value is enhanced or the useful life of the property increased, through a structural improvement, renovation or restoration of some aspect of the property.
Of course, the above is only a basic list of some of the terms you may encounter during a real estate transaction. There are many more terms you may need to understand if you decide to become involved in real estate. It is best to do a little research so that you fully understand every aspect of your real estate transaction.