Mortgage loan Study Guide

📖 Core Concepts Mortgage – a loan secured by real property; the property serves as collateral that can be seized if the borrower defaults. Borrower (mortgagor) – the person or entity receiving the loan and pledging the property. Lender (mortgagee) – the bank, credit union, or other institution providing the funds. Principal – original loan amount; declines as payments are applied. Interest – cost of borrowing, expressed as an annual percentage rate (APR). Loan‑to‑Value (LTV) Ratio – loan amount ÷ appraised property value; indicates lender risk. Amortization – repayment schedule where each payment covers interest first, then principal, gradually reducing the balance to zero. Fixed‑Rate vs. Adjustable‑Rate Mortgage (ARM) – fixed rate stays the same for the full term; ARM changes after an initial fixed period based on an index. Mortgage Insurance – protects the lender when LTV > 80 %; can be paid upfront, monthly, or rolled into the interest rate. Foreclosure – legal process allowing the lender to take and sell the property after default; can be judicial or non‑judicial. Recourse vs. Non‑recourse – recourse loans allow the lender to pursue the borrower for any deficiency after foreclosure; non‑recourse limits recovery to the collateral. 📌 Must Remember Amortization payment formula $$P = \frac{r \, L}{1-(1+r)^{-n}}$$ where P = monthly payment, r = monthly interest rate, L = principal, n = total payments. Typical U.S. loan term – 30 years (360 monthly payments). Standard LTV limits – conforming mortgages usually require ≤ 80 % LTV (20 % down). Debt‑to‑Income (DTI) rule – mortgage payments should be ≈ ⅓ of gross income for a conforming loan. Mortgage insurance required when LTV > 80 %; can be cancelled once LTV falls below 80 %. ARM adjustment triggers – index change + margin; caps may limit how much the rate can move each period and over the life of the loan. Interest‑only period – borrower pays only interest for a set time; principal due later, raising payment risk. Reverse mortgage – only for seniors; loan balance grows; repayment deferred until sale, death, or move. 🔄 Key Processes Underwriting Verify income, employment, credit history, and appraisal. Calculate DTI and LTV; flag any risk factors. Approve, conditionally approve, or deny the loan. Amortization Calculation Convert annual APR to monthly rate: r = APR / 12. Plug r, L, n into the payment formula to get P. Create an amortization schedule: each month, interest = previous balance × r; principal = P − interest. Balloon Payment Loan Compute regular payments as if fully amortized over a longer horizon. At the scheduled end, payoff remaining balance in one lump sum. Mortgage Insurance Cancellation Lender re‑appraises or tracks principal reductions. Once LTV ≤ 80 % (often after 5 years), borrower may request cancellation. 🔍 Key Comparisons Fixed‑Rate vs. ARM Fixed: same interest & payment for entire term → predictability. ARM: lower initial rate, later adjustments → potential rate increase risk. Recourse vs. Non‑recourse Recourse: lender can chase borrower for deficiency after foreclosure. Non‑recourse: lender limited to foreclosure sale proceeds only. Conforming vs. Non‑Conforming Conforming: meets Fannie / Freddie standards (LTV 70‑80 %, DTI ⅓). Easy to securitize. Non‑Conforming: exceeds limits (e.g., jumbo, subprime); higher pricing, harder to sell. U.S. vs. U.K. Mortgage Market U.S.: heavy reliance on securitization; many fixed‑rate loans. U.K.: variable‑rate dominance; lenders use retail deposits; usually recourse debt. ⚠️ Common Misunderstandings “Interest‑only means no principal ever repaid.” Only true during the interest‑only period; principal is due later or at maturity. “Higher LTV always means higher interest rate.” LTV influences risk; many lenders also consider credit score, DTI, and loan type. “Mortgage insurance is the same as homeowner’s insurance.” Mortgage insurance protects the lender, not the borrower’s property. “Foreclosure always ends the borrower’s debt.” In recourse states, borrowers may still owe a deficiency. 🧠 Mental Models / Intuition “Mortgage as a slowly shrinking iceberg.” Early payments melt the tip (interest) while the bulk (principal) stays hidden; later payments melt the bulk. “LTV = safety cushion.” The lower the LTV, the more equity the borrower has as a buffer against price drops. “ARM = roller coaster.” The ride starts smooth (fixed period), then the track (rate) can rise or fall based on market index. 🚩 Exceptions & Edge Cases Non‑recourse jurisdictions – borrower cannot be sued for deficiency after foreclosure. Interest‑only loans with balloon payment – require a refinancing plan before balloon due. Reverse mortgages – only available to seniors (usually 62+); must meet counseling requirements. Islamic mortgages – no interest; structured as purchase‑and‑rent or installment‑sale contracts (BBA, MM). 📍 When to Use Which Choose Fixed‑Rate when you want payment stability or expect rates to rise. Choose ARM if you plan to sell or refinance before the rate adjusts, or expect rates to fall. Use Mortgage Insurance when LTV > 80 % and the lender demands risk protection. Select Interest‑Only for cash‑flow flexibility (e.g., investment property) and when you can handle larger payments later. Opt for Reverse Mortgage only for qualified seniors who need cash and can live in the home long‑term. 👀 Patterns to Recognize “Early‑payment heavy interest” → amortization tables where the interest column shrinks each month. “LTV spikes → insurance requirement” – any loan with > 80 % LTV will trigger PMI/MI. “ARM adjustment notice” – look for index + margin wording; caps are usually listed nearby. “Balloon payment clause” – presence of a large final payment amount in the loan agreement. 🗂️ Exam Traps Distractor: “Mortgage insurance lowers the borrower’s interest rate.” Why wrong: It adds cost; it protects the lender, not the borrower’s rate. Distractor: “Foreclosure always eliminates borrower liability.” Why wrong: Only true in non‑recourse states; many jurisdictions allow deficiency judgments. Distractor: “All ARM rates reset annually.” Why wrong: Adjustment frequency varies (monthly, quarterly, annually) and depends on the loan terms. Distractor: “Higher LTV automatically means higher APR.” Why wrong: APR also depends on credit score, loan type, and market conditions. Distractor: “Islamic mortgages charge hidden interest.” Why wrong: They use profit‑sharing or lease‑to‑own structures; the profit is not labeled as interest but serves a similar economic function.