Glossary of Distressed Real Estate – I

Impound Account – An account into which funds are placed as a “reserve” for payment to a third party for a given purpose.  The most common impound accounts are required by lenders for taxes and insurance; the borrower pays into the account on a monthly basis so that there will be sufficient funds for the lender to pay the annual insurance premium and yearly property taxes when due.

Index – When used in reference to interest rates or any other payment obligation, the term usually refers to an independent table of figures whose accuracy is not in dispute, which is used to calculate the increase or decrease in the applicable interest rate due under a loan. A common example is the consumer price index or “CPI.”  Many adjustable rate mortgages contain provisions tying the applicable interest rate to a certain index such as LIBOR, the  London Inter-Bank Offering Rates. [Note: In July, 2012, the accuracy of LIBOR did fall into dispute with the Barclay’s scandal. – PCQ]

Inflation – An increase in the cost of goods and services.  As inflation increases, the value of the dollar decreases, since it takes more dollars to purchase the same goods and services.

Insolvency – A financial condition in which one’s liabilities exceed their assets.  Insolvency acts as an exception to the Cancellation of Date tax under IRC 108.  For more, go to this link.

Interest – A charge for the use of another’s money.  Interest must be “earned” in that it only becomes due after the lapse of time.  Interest is typically not paid in advance except in the case of discount points paid by a borrower to reduce the offered interest rate at the commencement of the loan.  Such points are essentially the prepayment of interest so that the lender’s yield is made comparable to what it would have been with the higher offered rate.

Interest Rate – The charge stated as an annual percentage of the unpaid principal balance due on a loan.  For example, an interest rate of 5.00% on $100,000 is $5,000 annually if no principal is paid back during that year.  If the loan called for 12 equal monthly payments of principal and interest, the 5.00% would be charged first to the interest due on the principal balance and the remainder would be applied to reduce the principal.

Interest-Only Option – A payment alternative during the early years of a loan.  This option was created during the easy-credit years of 2005-2007 as a “sweetener” or incentive for borrowers to borrow more than they could normally afford if required to pay the fully amortized monthly payments of principal and interest.  For example, a $300,000 30-year loan at 6.00% would carry monthly interest-only payments of $1,500.  But the monthly amortization of principal and interest would be nearly $1,800 per month.  And – assuming no principal payments for the first five years – if the loan reset at the end of the fifth year, the monthly payments of principal and interest amortized over the remaining 25 years would become approximately $1,932.00 per month