Deck 5: Adjustable and Floating Rate Mortgage Loans

Question 1

$\begin{array}{cccc}\begin{array}{l}\\Initial ~Interest~ Rate \\Loan ~Maturity~ years) \\\% Margin ~Above~ Index \\Adjustment ~Interval \\Points \\Interest ~Rate~ Cap\\\end{array}\begin{array}{cccc}\text { LOAN 1 } & \text { LOAN 2 } & \text { LOAN 3 } & \text { LOAN 4 } \\\hline ? & ? & ? & ? \\20 & 20 & 20 & 20 \\3 \% & -- & 3 \% & 3 \% \\1 \mathrm{yr} & -- & 1 \mathrm{yr} & 1 \mathrm{yr} . \\1 \% & 1 \% & 1 \% & 1 \% \\\text { NONE } & --- & 1 \% / \mathrm{yr} . & 3 \% / \mathrm{yr} .\end{array}\end{array}$

-Which loan in the above table is a FRM?

A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4

Answer 1

Loan 2

Question 2

Which is NOT a component of an ARM?

A) A margin
B) An index
C) A chapter
D) Caps

Answer 2

A chapter

Question 3

A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4%, after that, the rate can reset with a 2% annual rate cap. On the reset date, the composite rate is 5%. What would the Year 3 monthly payment be?

A) $955
B) $1,067
C) $1,071
D) $1,186
E) Because of the rate cap, the payment would not change.

Answer 3

$1,067

Question 4

Lender's can partially avoid estimating interest rates by tying an ARM to an interest rate index.

Question 5

$\begin{array}{cccc}\begin{array}{l}\\Initial ~Interest~ Rate \\Loan ~Maturity~ years) \\\% Margin ~Above~ Index \\Adjustment ~Interval \\Points \\Interest ~Rate~ Cap\\\end{array}\begin{array}{cccc}\text { LOAN 1 } & \text { LOAN 2 } & \text { LOAN 3 } & \text { LOAN 4 } \\\hline ? & ? & ? & ? \\20 & 20 & 20 & 20 \\3 \% & -- & 3 \% & 3 \% \\1 \mathrm{yr} & -- & 1 \mathrm{yr} & 1 \mathrm{yr} . \\1 \% & 1 \% & 1 \% & 1 \% \\\text { NONE } & --- & 1 \% / \mathrm{yr} . & 3 \% / \mathrm{yr} .\end{array}\end{array}$

-Which loan in the above table should have the lowest initial interest rate?

A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4

Question 6

ARMs help lenders combat unanticipated inflation changes, interest rate changes, and a maturity gap.

Question 7

Characteristics of a PLAM include an increasing mortgage payment and an adjusting loan balance tied to an index.

Question 8

PLAMs have been very popular with lenders.

Question 9

A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4%, after that, the rate can reset with a 5% annual payment cap. On the reset date, the composite rate is 6%. What would the Year 3 monthly payment be?

A) $955
B) $1,067
C) $1,003
D) $1,186
E) Because of the payment cap, the payment would not change.

Question 10

The default risk of a FRM is higher than the default risk of an ARM.

Question 11

$\begin{array}{cccc}\begin{array}{l}\\Initial ~Interest~ Rate \\Loan ~Maturity~ years) \\\% Margin ~Above~ Index \\Adjustment ~Interval \\Points \\Interest ~Rate~ Cap\\\end{array}\begin{array}{cccc}\text { LOAN 1 } & \text { LOAN 2 } & \text { LOAN 3 } & \text { LOAN 4 } \\\hline ? & ? & ? & ? \\20 & 20 & 20 & 20 \\3 \% & -- & 3 \% & 3 \% \\1 \mathrm{yr} & -- & 1 \mathrm{yr} & 1 \mathrm{yr} . \\1 \% & 1 \% & 1 \% & 1 \% \\\text { NONE } & --- & 1 \% / \mathrm{yr} . & 3 \% / \mathrm{yr} .\end{array}\end{array}$

-With which loan in the above table does the lender have the lowest interest rate risk?

A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4

Question 12

Which of the following statements regarding negative amortization in the previous question is true?

A) The Year 3 payments are less than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is higher than at the end of Year 2.
B) The Year 3 payments are more than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is higher than at the end of Year 2.
C) The Year 3 payments are less than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is lower than at the end of Year 2.
D) The Year 3 payments are more than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is lower than at the end of Year 2.

Question 13

ARMs eliminate all the lender's interest rate risk.

Question 14

ARMs were developed because lenders were tired of offering a limited selection of loan alternatives to borrowers.

Question 15

Which of the following descriptions most accurately reflects the risk position of an ARM lender in comparison to that of a FRM lender? Interest Rate Risk Default Risk

A) Higher Higher
B) Lower Lower
C) Higher Lower
D) Lower Higher

Question 16

Assume that the loan in the previous question allowed for negative amortization. What would be the outstanding balance on the loan at the end of Year 3?

A) $190,074
B) $192,337
C) $192,812
D) $192,926

Question 17

Negative amortization reduces the principal balance of a loan.

Question 18

Under which scenario is negative amortization likely to occur? Payment Cap Interest Rates

A) None Increasing
B) None Decreasing
C) 7.5% Increasing
D) 7.5% Decreasing

Question 19

The floor of an ARM is the maximum reduction of payments or interest rates allowed.

Question 20

A major benefit of a PLAM is the mortgage payment increases closely following borrower salary increases.

Question 21

Which of the following clauses leads to higher risk for an ARMs lender?

A) Negative amortization is not allowed when interest is not covered by the payment due to a payment cap
B) There is floor for payments
C) Adjustment interval is longer than one year
D) All of the above

Question 22

The expected cost of borrowing does NOT depend on which of the following provisions?

A) The frequency of payment adjustments
B) The inclusions of caps and floors on the interest rate, payment or loan balances
C) The spread over the index chosen for a given ARM
D) None of the above

Question 23

Given that every other factor is equal, which of the following ARMs will have the lowest expected cost?

A) An ARM with payment caps and negative amortization
B) An ARM with interest rate caps
C) An ARM with longer Adjustment interval
D) An ARM with no caps or limitations

Question 24

Which of the following is a disadvantage of PLAMs?

A) Lenders face high levels of interest rate risk under PLAMs.
B) Fewer homebuyers are likely to qualify for financing using PLAMs in comparison to CPMs.
C) The price level used to index PLAMs is measured on an ex post basis and historic prices may not be an accurate reflection of future price.
D) All of the above.

Question 25

If one of the terms of an ARM read, interest is capped at 2%/5%, what would that mean?

A) The borrower can choose the cap he wants by simply circling the appropriate choice
B) The interest rate has a 2% annual cap rate and a 5% lifetime cap rate
C) The interest rate has a 5% annual cap rate and a 2% lifetime cap rate
D) The interest rate has a 2% annual cap rate and a 5% floor cap rate

Question 26

If an ARM index increased 15%, the negative amortization on a loan with a 5% annual payment cap is calculated by:

A) Using the same payment as last year and deducting 5% from the principal balance
B) Increasing the payment by 5%
C) Totaling the difference between the payment as if no cap existed and the 5% capped payment
D) Compounding the difference between the payment as if no cap existed and the 5% capped payments

Question 27

In order to calculate the APR for an ARM, you must,

A) Only use the first year's given interest rate
B) Estimate interest rates over the life of the loan
C) Assume the worst case scenario and use interest rates at their highest possible point over the life of the loan
D) Use only the first five year's interest rates because they can easily be estimated and most people only own a property for five years