Loans Mortgage Loan 2 — Questions and Answers
Question 1: What is the purpose of private mortgage insurance (PMI)?
- It protects the lender if the borrower defaults (Correct answer)
- It covers the borrower's life insurance
- It pays for homeowner's insurance
- It guarantees the property's appraised value
Correct answer: It protects the lender if the borrower defaults
PMI protects the lender—not the borrower—against losses if the borrower defaults on the loan.
Question 2: Which mortgage type features an interest rate that adjusts periodically based on a market index?
- Fixed-rate mortgage
- Adjustable-rate mortgage (ARM) (Correct answer)
- Balloon mortgage
- Interest-only mortgage
Correct answer: Adjustable-rate mortgage (ARM)
An adjustable-rate mortgage (ARM) has an interest rate that changes at set intervals tied to a benchmark index such as SOFR.
Question 3: A borrower takes out a 5/1 ARM. What does the '1' represent?
- The loan adjusts once over its lifetime
- The rate adjusts every 1 year after the initial fixed period (Correct answer)
- The margin is 1%
- The first payment is due in 1 month
Correct answer: The rate adjusts every 1 year after the initial fixed period
In a 5/1 ARM, the '5' is the initial fixed-rate period in years and the '1' is how often (in years) the rate adjusts afterward.
Question 4: What does a mortgage rate 'cap' limit?
- The maximum loan amount a borrower can receive
- How much the interest rate can increase per adjustment period or over the life of the loan (Correct answer)
- The maximum down payment percentage required
- The lender's profit margin on the loan
Correct answer: How much the interest rate can increase per adjustment period or over the life of the loan
Rate caps on ARMs restrict how much the interest rate can rise during each adjustment period and over the loan's lifetime.
Question 5: Which federal law requires lenders to disclose the Annual Percentage Rate (APR) to mortgage borrowers?
- The Fair Credit Reporting Act (FCRA)
- The Truth in Lending Act (TILA) (Correct answer)
- The Real Estate Settlement Procedures Act (RESPA)
- The Equal Credit Opportunity Act (ECOA)
Correct answer: The Truth in Lending Act (TILA)
TILA (Regulation Z) requires lenders to disclose the APR and other loan terms so borrowers can compare costs accurately.
Question 6: A homebuyer makes a 10% down payment on a $400,000 home. Approximately how much will they pay annually for PMI if the rate is 0.8%?
- $3,200
- $2,880 (Correct answer)
- $400
- $1,600
Correct answer: $2,880
PMI is calculated on the loan amount ($360,000), so 0.8% × $360,000 = $2,880 per year.
Question 7: At what loan-to-value (LTV) ratio can a borrower typically request cancellation of PMI on a conventional loan?
- 90%
- 85%
- 80% (Correct answer)
- 75%
Correct answer: 80%
Under the Homeowners Protection Act, borrowers can request PMI cancellation once LTV reaches 80% based on original value.
Loans Mortgage Loan 2
What is the purpose of private mortgage insurance (PMI)?