BMO Credit & Lending Fundamentals 2 — Questions and Answers
Question 1: What does loan amortization refer to?
- The process of writing off a loan as a loss after default
- The gradual repayment of a loan through scheduled payments covering both principal and interest (Correct answer)
- The adjustment of a variable interest rate over the loan term
- The fee charged by a bank to originate a new loan
Correct answer: The gradual repayment of a loan through scheduled payments covering both principal and interest
Amortization describes how a loan is paid down over time through regular payments that reduce both the outstanding principal and interest owed.
Question 2: What is the key difference between a fixed-rate and a variable-rate loan?
- Fixed-rate loans are only available for mortgages, while variable-rate loans apply to all products
- A fixed rate stays constant throughout the loan term, while a variable rate fluctuates with market benchmarks (Correct answer)
- Variable-rate loans always carry lower interest than fixed-rate loans
- Fixed-rate loans require collateral, whereas variable-rate loans are always unsecured
Correct answer: A fixed rate stays constant throughout the loan term, while a variable rate fluctuates with market benchmarks
A fixed rate provides payment certainty for the borrower, while a variable rate changes in response to benchmark rates such as the prime rate, affecting monthly payments.
Question 3: What is a Home Equity Line of Credit (HELOC)?
- A government-insured mortgage for first-time homebuyers
- A revolving credit facility secured by the borrower's home equity (Correct answer)
- A fixed-term loan used to purchase investment properties
- An unsecured personal loan granted based on home ownership
Correct answer: A revolving credit facility secured by the borrower's home equity
A HELOC allows homeowners to borrow against the equity in their home on a revolving basis, using the property as collateral.
Question 4: What is the prime rate in Canadian banking?
- The interest rate charged between chartered banks for overnight lending
- The benchmark lending rate set by major banks, typically tied to the Bank of Canada's policy rate (Correct answer)
- The maximum rate lenders may charge retail customers by law
- The rate applied exclusively to government-guaranteed student loans
Correct answer: The benchmark lending rate set by major banks, typically tied to the Bank of Canada's policy rate
The prime rate is a benchmark used by banks like BMO to price variable-rate loans and lines of credit, and it moves in tandem with the Bank of Canada's overnight rate.
Question 5: What does a loan-to-value (LTV) ratio indicate?
- The ratio of monthly loan payment to the borrower's monthly income
- The proportion of a property's value financed by the loan relative to its appraised value (Correct answer)
- The percentage of interest versus principal in each loan payment
- The lender's expected return on a lending portfolio
Correct answer: The proportion of a property's value financed by the loan relative to its appraised value
LTV is calculated by dividing the loan amount by the appraised property value; a lower LTV indicates less lender risk because the borrower has more equity in the asset.
Question 6: What is the primary function of a credit bureau (e.g., Equifax, TransUnion)?
- To set national interest rate policies on behalf of the central bank
- To collect, maintain, and report consumer credit history to lenders (Correct answer)
- To insure lenders against borrower defaults
- To provide direct consumer lending at regulated rates
Correct answer: To collect, maintain, and report consumer credit history to lenders
Credit bureaus aggregate borrowing and repayment data from lenders and provide credit reports and scores that help lenders assess borrower risk.
Question 7: What is a balloon payment in the context of a loan?
- A penalty fee charged for early repayment of a loan
- An additional monthly surcharge added when a borrower misses a payment
- A large lump-sum payment due at the end of a loan term after smaller periodic payments (Correct answer)
- A promotional payment deferral offered during the first year of a mortgage
Correct answer: A large lump-sum payment due at the end of a loan term after smaller periodic payments
A balloon payment is a large final payment due at loan maturity, common in structures where regular installments do not fully amortize the principal.
BMO Credit & Lending Fundamentals 2
What does loan amortization refer to?