EXAM 14
11) If an ARM has a lifetime cap of 6%, and starts with an initial interest rate of 5%, but the index rate increases 1% per year over the next 10 years, what is the effect on the maximum interest rate under the terms of this loan: A. The maximum interest rate will be 11% B. The maximum interest rate will be 12% because the cap is soft the first year and gives way to the rising index rate C. The maximum interest rate is undetermined because of the pending interpretation of Dodd-Frank D. The maximum interest rate could be 16%
Answer: A. Correct. 6% initial rate plus 5% cap = 11%.
17) All of the following are true for an interest-only (I-O) ARM, except: A. The payment can never increase during the I-O period B. An interest-only ARM is still fully amortized C. The longer the I-O period, the higher the monthly payments will be after the I-O period ends D. Payments can increase after the I-O period, even if interest rates go down
Answer: A. The payments can increase because for some I-O ARMS, the interest rate adjusts during the I-O period as well.
4) With an ARM, which of the following best describes what function the index serves: A. It indicates the approximate cost of money in the marketplace at a given time B. It dictates how much the loan interest rate must fall if interest rates fall C. It indicates how much money the lender will make over and above the stated interest rate D. It limits the number of percentage points an interest rate can increase during each adjustment period
Answer: A. This is correct, according to the various well-recognized indexes: (1) The 1-year constant-maturity Treasury (CMT), (2) The Cost of Funds Index (COFI), and the (3) London Interbank Offered Rate (LIBOR).
1) With an ARM, what is the shortest period of time the interest rate or payment amount could remain in effect: A. One month B. Six months C. One year D. Five years
Answer: A. This is correct.
37) A permanent buydown means which of the following: A. The interest rate is reduced throughout the term of the loan B. The interest rate is a level-payment reduction C. The discount points are always paid by the seller D. The interest rate is reduced for at least four years
Answer: A. This is correct. To issue a permanent buydown, the lender determines what the buydown amount is and the borrower will have to comply with the lender's underwriting standards.
9) What will happen with an ARM loan with a fully-indexed rate of 6% with a periodic adjustment cap of 2% if the index rate has risen 3% prior to the first 1-year adjustment: A. The second year payment will be capped at 8% B. The second year payment will be at 9% because a floating index rate supersedes a periodic adjustment cap the first year C. The second year payment will be the same as without a periodic adjustment cap D. The margin will adjust, causing the payment to rise
Answer: A. Yes, the 2% periodic adjustment cap allows the interest to rise to only 6%.
12) Which of the following best describes how payment caps on an ARM loan work: A. They prevent monthly payments from rising faster than the agreeable cap B. They prevent the borrower from unknowingly getting deeper into debt C. They prevent interest rates from increasing on the loan faster than the borrower can afford to pay on a monthly basis D. They protect the borrower all around from financial disaster
Answer: A. Yes, this is all payment caps do. They prevent monthly payments from rising faster than the agreeable cap. But look at the next question to discover other effects of the payment cap.
30) All of the following are true about converting an ARM to a fixed-rate mortgage, except: A. A borrower may have an agreement that allows conversion at stipulated times during the term of the loan B. Up-front fees will generally be less for a convertible ARM because the lender wants the borrower to convert C. When a borrower converts, the new rate is generally set using a formula given in the loan documents D. A convertible ARM may require a fee at the time of conversion
Answer: B. Interest and upfront fees may be higher for a convertible ARM.
32) All of the following are true regarding APR on an ARM, except: A. The APR is an important part of comparing the costs of getting a loan B. The APR on an ARM can be compared directly to the APR on a fixed-rate loan C. The APR on an ARM can be compared directly to the APR of a similar ARM D. The APR on an ARM must be based on the lender's margin and the composite annual percentage rate
Answer: B. The composite annual percentage rate is based on the initial payment rate and the fully indexed rate that would exist for the remaining years on the loan term. This is why the APR on an ARM cannot be compared directly to the APR on a fixed-rate loan.
48) Using the same numbers as Question 45, which of the following is closest to the annual subsidy for the third year: A. $2000 B. $3000 C. $4000 D. $5000
Answer: B. The payment at 6% is $1000. At 4.5% interest, the payment is $750/mo I.O. The subsidy is $250/mo x 12 = $3000.
2) With an ARM, if interest rates are stable and do not rise, can payments rise and why: A. No, because rise in payments is tied to an increase in interest rates B. Yes, because an interest rate cap may have held the borrower's rate and payment below what it would have been if the change in the index rate had been fully applied C. No, because this is prevented by the periodic adjustment cap D. Yes, because of the floating margin
Answer: B. The rate on an ARM can go up at any scheduled adjustment date when the lender's standard ARM rate (index plus margin) is higher than the rate they are paying before the adjustment. The increase in interest that was not imposed because of the rate cap may carry over to future rate adjustments.
43) A 3-2-1 buydown means which of the following: A. Discount points subsidize the payments for 3 years, a 3% subsidy the first year, a 2% subsidy the second year, and a 1% subsidy the third year B. Discount points subsidize the payments for 3 years, but the percentage of the subsidy is not stipulated in this description C. Discount points subsidize the payments for 3 years, but the percentage of the subsidy is not stipulated in any documentation D. Discount points paid by the seller subsidize the payments for three years at a rate to be agreed upon later
Answer: B. The subsidy could be paid by the buyer or seller, and the percentage is not described in the numbers 3-2-1, just the number of years.
47) Using the same numbers as Question 45, which of the following is closest to the annual subsidy for the second year: A. $5000 B. $4000 C. $3000 D. $2000
Answer: B. The subsidy is $333/mo. x 12 = $3996.
40) A level payment buydown means which of the following: A. The interest rate reduction remains constant throughout the term of the loan B. The interest rate reduction remains constant throughout the buydown period C. The interest rate reduction is not variable for any period of time D. The interest rate reduction is constant and is always paid by the buyer
Answer: B. This is correct.
8) Which of the following best describes the fully-indexed rate: A. The rate currently indicated by one of the traditional well-recognized indexes such as LIBOR, COFI, or CMT B. The current rate indicated by one of the well-recognized indexes plus the margin C. The current rate indicated by one of the well-recognized indexes minus the margin D. The fully-indexed rate equals the initial index value
Answer: B. This is correct.
10) What does it mean when an ARM loan has a 2/6 cap: A. The loan can adjust twice for a maximum of 6% B. The periodic adjustment cap is 2%, and the lifetime cap is 6% C. The interest rate can adjust two times per year, and caps out at 6% D. The lifetime cap is 2% and can adjust every six months
Answer: B. This is correct. The first number (2) is the periodic adjustment rate cap, and the second number (6) is the lifetime rate cap.
15) What does an ad that advertises a 3/27 ARM mean: A. A lifetime cap of 3% that can adjust every 27 months B. A 30-year loan at a fixed rate for 3 years, adjustable for the remaining 27 years C. A 27-year loan fixed for the first 3 years D. A loan with a starting rate of 3% with a period rate cap of 2.7%
Answer: B. This is correct. The first number tells us how many years the interest rate will be fixed. The second number tells us the number of years the rate will be adjustable. These numbers do not adjust how often the rate will adjust. This will be based on agreement, commonly every 6 months with this structure.
39) All the following are true regarding the note rate with buydowns, except: A. On a permanent buydown, the note rate will be the actual reduced interest rate B. On a temporary buydown, the qualifying rate will generally be start rate, not the note rate C. On a temporary buydown, the qualifying rate will generally be the note rate, not the start rate D. The note rate refers to the nominal rate, the rate stated in the note
Answer: B. This is the correct answer because the note rate more accurately reflects the rate the borrower will have to pay for most of the term.
44) A borrower is obtaining a $200,000 loan at 6% for 30 years, and wants a 3-2-1 buydown. He wants to buy the loan down 2.5% the first year, 2% the second year, and 1.5% the third year. Which of the following is closest to the monthly subsidy for the first year: A. $220 B. $320 C. $420 D. $480
Answer: C. At 3.5% interest, the payment is $583/mo I.O. The payment at 6% is $1000. $1000 - $583 = $417 subsidy.
46) Using the same numbers as Question 45, which of the following is closest to the monthly subsidy for the second year: A. $175 B. $225 C. $325 D. $375
Answer: C. At 4% interest, the payment is $667/mo I.O. The payment at 6% is $1000. $1000 - $667 = $333/mo. subsidy.
42) A borrower wishes to have a graduated 2/1 buydown. To help pay for the buydown, the borrower will deposit cash into an interest-bearing escrow account. If the loan is for $200,000 at 6% for 30 years, and the borrower wants 2% below the interest rate the first year, and 1.5% the second year, which of the following is closest to the total subsidy to pay for the buydown: A. $3,000 B. $5,000 C. $7,000 D. $7,500
Answer: C. At 6%, the payment on a $200,000 loan for 30 years is $1,000. At 4%, the payment is $667. The subsidy is $333/mo x 12 = $3996. At 4.5%, the payment is $750. The subsidy is $250/mo x 12 = $3000. $3000 + $3996 = $6996, or $7,000. At the end of the second year, the effective interest rate for the loan reverts to the agreed upon 6%.
41) A borrower wishes to buydown a $200,000 loan at 6% interest for 30 years. The buydown will be for 3 years and will bring the interest rate down to 5% for those 3 years. Which of the following is closest to the total buydown for the 3 years: A. $2,000 B. $4,000 C. $6,000 D. $8,000
Answer: C. For the sake of simplicity and illustration, any calculations for Questions 42-50 are based on interest only. At 6%, the payment on a $200,000 loan for 30 years is $1,000. At 5%, the payment is $833. The difference is $167. $167 x 36 months = $6012, the amount of the buydown. The lender makes exactly the same amount of money.
49) Using the same numbers as Question 45, which of the following is closest to the total 3-2-1 buydown cost: A. $8000 B. $10,000 C. $12,000 D. $13,500
Answer: C. Subsidy for the first year = $5004, second year = $3996, third year = $3000 for a total of $12,000.
6) Which of the following could reduce the margin on a borrower's ARM loan: A. The lender is not interested in making a large profit B. The lender is willing to look the other way on administrative expenses C. The borrower has a better credit rating D. The feds have reduced it based on the parameters of the loan
Answer: C. The lenders regard a borrower with better credit as less risk.
45) Using the same numbers as Question 45, which of the following is closest to the annual subsidy for the first year: A. $3000 B. $4000 C. $5000 D. $6000
Answer: C. The subsidy is $417/mo x 12 = $5004.
16) Which of the following is true of an interest-only (I-O) ARM: A. An interest-only ARM is not a fully amortized loan B. On an interest-only ARM, the interest rate cannot adjust during the I-O period C. Payments increase after the I-O period, even if interest rates stay the same D. The shorter the I-O period, the higher the monthly payments will be after the I-O period ends
Answer: C. This is correct, because the borrower must start paying back the principal.
3) With an ARM, the period of time between rate changes is called which of the following: A. The margin B. The carryover C. The adjustment period D. The interim
Answer: C. This is correct.
5) What kind of authority does the Consumer Financial Protection Bureau have: A. None B. Limited authority subject to the regulators of the Federal Reserve C. Rule making and enforcement authority over many consumer financial laws D. Unlimited power over all federally insured financial institutions
Answer: C. This is correct.
21) A borrower can be certain of which of the following when obtaining a loan with starter rates or teaser rates: A. He or she is getting a good deal B. Even when the rate increases, the payments will still be lower than had the discount not been obtained C. Any savings during the discount period may be offset by higher payments over the remaining life of the mortgage D. As long as the discount points are paid by the seller, who cares
Answer: C. This is correct. Nothing is free. It's like the mechanic in the TV commercial says, "You can pay me now, or you can pay me later." Analyze the deal and compare future payments with those of a full-indexed ARM. The teaser rates may get the borrower into the commitment, but are not designed to save the borrower money.
33) What is a buydown: A. A buydown plan always lowers the monthly payment for the entire term of the loan B. A buydown plan always requires the buyer to pay discount points upfront to lower the monthly payment C. A buydown plan requires additional funds to be paid to the lender upfront as prepaid interest, and therefore lower the interest rate and monthly payments D. The additional funds to be paid to the lender upfront are sometimes called bonus points
Answer: C. This is correct. These additional funds are often called discount points, and either buyer or seller can pay them. They may lower the payments for the entire term of the loan (called a permanent buydown) or for a limited time.
36) Which of the following best describes how a seller-paid buydown works: A. The seller pays the upfront discount points out-of-pocket for the buyer B. The buyer signs the note for the smaller amount reflecting the buydown C. The buyer signs the note for the full amount but the seller agrees to receive less D. A seller-paid buydown is always a permanent buydown
Answer: C. Yes, the seller does not pay the discount points out-of-pocket, but just receives less, enabling the lender to receive the same as if the rate was not discounted.
14) A Hybrid ARM is a mixture of fixed rate combined with adjustable rate in order to successfully retire the debt. What does a 5/1 ARM mean: A. It has a lifetime cap of 5% and can adjust every year B. It is a short term five-year loan that can adjust once a year C. It is fixed for 5 years and can adjust every year D. It is an interest only loan, due and payable in 5 years
Answer: C. Yes, this is what it means. The first number tells us how long the fixed rate will be in effect, and the second number tells us how often the rate will adjust after the initial fixed-rate period.
24) Which of the following practices or circumstances could cause a borrower to owe more than his/her home is worth: A. Home values are not rising quickly B. The borrower makes minimum payments C. The borrower falls into negative amortization D. Any of the above
Answer: D. Any one of these factors or any combination may result in a borrower owing more than their home is worth. They may find it difficult to refinance to get a lower rate or monthly payment.
29) How are additional payments of principal with the monthly payment regarded on an ARM: A. Most of the time they are regarded as a partial prepayment and incur a penalty B. Most of the time the lender allows such payments of principal and they do not incur a prepayment penalty C. It is based on the agreement between borrower and lender D. Both "B" and "C"
Answer: D. Correct. A borrower should understand the lender's terms on this before entering into the loan.
28) With a hybrid ARM of 2/28, how should a borrower analyze the expense to refinance with regard to a prepayment penalty: A. The borrower would have to consider the length of time the prepayment penalty was in effect B. The borrower would have to consider when the loan would adjust C. The borrower would have to consider the amount of the prepayment penalty D. All of the above
Answer: D. Correct. If the loan has a rate and payment adjustment after the 2nd year, but the prepayment penalty is in effect for 5 years, it may be too costly to refinance when the first adjustment is made.
13) Which of the following best describes how a borrower with payment caps on an ARM loan could get in trouble: A. They can't. They are basically protected and able to stay within their budget B. If their loan has payment caps but not period adjustment rate caps C. Negative amortization D. Both "B" and "C"
Answer: D. Correct. Let's say a borrower's monthly payment is $1000 P&I with a payment cap of 7.5%. Let's say the index rate on their loan goes up 3%, raising the payment by $300. Because of their payment cap, the borrowers don't have to pay $1300 per month. They have to pay only $1075 per month. But the rate is the rate, and the $225 per month they are not paying is being added to the balance of their loan. $225 x 12 months = $2700 additional loan balance after just one year. This is called negative amortization. After fives years of this, the loan balance would be $13,500 more than the initial balance. At that point, the lender will recast (recalculate) the loan payment so that the loan will fully amortize during the last 25 years of the term. The payment can go up substantially, and the payment cap does not apply to this adjustment. This is one way to experience PAYMENT SHOCK
19) In which of the following ways can a borrower find himself in a negative amortization situation with an ARM loan: A. A borrower could choose to pay less than interest-only on a payment-option ARM B. A borrower could have payment caps that kept his payment low when interest rates increased, but added to the balance of the loan C. When a lender recasts the payment for the remaining term of the loan D. Any of these will land the borrower in negative amortization
Answer: D. Correct. Not keeping up with current interest demands will cause the unpaid interest to be added to the balance of the loan. This is negative amortization.
22) Comparing the following types of loans, with minimum payments being made, which of the following loans will result in the highest payments after seven years: A. 30-year fixed B. 5/1 ARM C. 5/1 I-O ARM D. Payment-option mortgage
Answer: D. Deferment of interest due will ultimately cost the borrower more. He or she will be paying interest on interest. Based on a $200,000 loan at 30 years and 6% interest, minimum payments on the payment-option loan will be $1708.22 in the 7th year, whereas payments in the 7th year of the 30-year fixed rate loan will be $1199.10, same as the first year.
38) On a $100,000 loan and $6,000 paid to the lender as a permanent ½% interest rate buydown by the seller, which of the following best describe the working of the transaction: A. The buyer receives only $94,000 to finance the home B. The buyer signs a note for the full $100,000 C. The buyer transfers the loan proceeds of $94,000 to the seller without making up the difference D. All of the above
Answer: D. In effect, the seller paid $6,000 to the lender so the lender would make the loan at a lower interest rate to the buyer. The lender comes out the same.
23) How could a negative amortization cap more than double a borrower's monthly payment: A. It can't. This would be unfair to the borrower B. If the negative amortization cap was attained and the loan was recast C. If the lifetime interest rate cap had been reached D. Both "B" and "C"
Answer: D. Let's say an ARM starts out at $400,000, 6% fully indexed rate, 6% lifetime interest rate cap, 30 year term. Calculations will be done on an interest only basis for the sake of illustration. The index rises and the borrower quickly falls into negative amortization. The negative amortization cap is 25% of the original loan amount. After 5 years, the loan is recast. Instead of the initial payments of $2,000 based on a $400,000 loan at 6%, the loan is recast with a balance of $500,000 (25% more than the starting balance) at the lifetime cap (12%) for the remaining term of 25 years. The new payment is $5,000 per month, and the payment cap does not apply.
35) If a borrower takes out a $200,000 loan at 6% fixed-rate for 30 years and wants to buy down the rate to 5.75%, what will be the effect on the loan and the borrower: A. The borrower will lower his/her P&I payment by $41.67 B. The borrower will have to stay in the loan for eight years to realize the advantages of the buydown C. If the borrower sells or refinances sooner than eight years, he/she will not recapture what they paid in the upfront discount points D. All of the above are true
Answer: D. One discount point equals one percent of the loan amount. To lower the interest rate 1/8 of one percent on a 30-year loan requires one point, so to lower the interest rate ¼ of one percent as in this question, the borrower must pay 2 points, or $4,000 up front. $4,000 ÷ $41.67 = 96 months, or eight years to break even.
31) All of the following are true about graduated-payment loans except: A. They are fixed-rate loans that start at one rate and change to another B. Their payments change just as with adjustable rate mortgages C. The borrower's payments will rise according to the terms of the contract D. Though not considered adjustable rate mortgages, they are still tied to one of the major indexes
Answer: D. Payments change based on the agreed upon terms in the contract, not by financial indexes.
34) What are the advantages to the buyer of a buydown: A. It may help the buyer qualify for the loan B. It lowers the buyers monthly payments C. It is charged to the seller on the GFE D. Both "A" and "B"
Answer: D. This is correct.
7) Which of the following best describes the margin with an ARM loan: A. The difference between the fully indexed rate and the index B. Extra percentage points of interest added by the lender to ensure coverage of expenses and earning of profits C. A padding of profit margin authorized by the feds and fluctuating throughout the term of the loan D. Both "A" and "B"
Answer: D. This is correct.
27) Which of the following could mitigate having a prepayment penalty on an ARM: A. Lower origination fees B. Lower interest rates C. Lower upfront costs D. Any of the above
Answer: D. This is correct. A borrower would have to analyze the prepayment penalty fees as they are offset by lower origination fees, interest rates, and other upfront costs. There could be a tradeoff, and the lender may be willing to reduce or eliminate a prepayment penalty based on the amount the borrower pays for these other costs.
26) With an ARM, what is the difference between a hard prepayment penalty and a soft prepayment penalty: A. A hard prepayment penalty is a penalty to be paid for prepaying the loan for any reason B. A soft prepayment penalty is a penalty to be paid only if the borrower refinances the loan C. A soft prepayment penalty would not require a fee if the property is sold D. All of these are true
Answer: D. This is correct. Prepayment penalties on ARMS may exist for the first 3-5 years of the loan, and may require fees even if only a partial prepayment is made.
25) If a borrower has an ARM and doesn't want to risk any increases in the interest rate or payment amount, what options does a borrower have: A. They could refinance the loan B. They could sell the property, thereby getting out of the loan C. They could convert to a fixed-rate loan D. Any of the above
Answer: D. Yes, all of these are possibilities, but the question is, at what cost? Prepayment penalties vary and may be prohibitive.
20) In which of the following situations could a borrower find him/herself surprised by payment shock: A. Not calculating for the payment of taxes and insurance in their monthly payment B. Going through periods of paying less than interest-only when payment options present themselves C. Having payment caps that keep payments affordable but do not allow the borrower to keep up with interest increases to their loan D. All of the above
Answer: D. Yes, any and all of these could cause PAYMENT SHOCK for a borrower when they finally have to pay the interest or other fees that have been accruing.
18) A borrower with a payment-option ARM can choose among which of the following payment options each month: A. A traditional payment of principal and interest B. An interest-only payment C. A minimum payment of less than the interest due D. Any of the above
Answer: D. Yes, these are the traditional options for a payment-option ARM.
