Mortgage Terms 3 — Questions and Answers
Question 1: What is an 'escrow account' in mortgage servicing?
- An account holding funds the lender invests on the borrower's behalf
- An account managed by the servicer to collect and pay property taxes and homeowner's insurance (Correct answer)
- A savings account the borrower must maintain as loan collateral
- An account used to store the down payment before closing
Correct answer: An account managed by the servicer to collect and pay property taxes and homeowner's insurance
An escrow account held by the mortgage servicer collects monthly amounts from the borrower to cover property taxes and homeowner's insurance when they become due.
Question 2: What does 'underwater' mean when referring to a mortgage?
- The property is located in a flood zone
- The borrower owes more on the mortgage than the home is currently worth (Correct answer)
- The loan has a variable interest rate below the prime rate
- The mortgage payment exceeds 50% of the borrower's income
Correct answer: The borrower owes more on the mortgage than the home is currently worth
A mortgage is 'underwater' (also called negative equity) when the outstanding loan balance exceeds the current market value of the property.
Question 3: What is a 'balloon payment' in a mortgage?
- An extra payment made voluntarily to reduce principal
- A large lump-sum payment due at the end of a loan term that pays off the remaining balance (Correct answer)
- A monthly payment that increases each year
- A penalty payment for missing a scheduled payment
Correct answer: A large lump-sum payment due at the end of a loan term that pays off the remaining balance
A balloon payment is a large final payment due at the end of a balloon mortgage term, representing the remaining principal that was not fully amortized.
Question 4: What is 'debt-to-income ratio' (DTI) used for in mortgage lending?
- Measuring how much of a borrower's home equity is used as collateral
- Comparing a borrower's monthly debt obligations to their gross monthly income to assess repayment ability (Correct answer)
- Calculating the property's value relative to similar homes in the area
- Determining how much interest has been paid versus principal
Correct answer: Comparing a borrower's monthly debt obligations to their gross monthly income to assess repayment ability
DTI ratio measures the percentage of a borrower's gross monthly income that goes toward paying debts, helping lenders evaluate whether the borrower can manage additional debt.
Question 5: What is a 'home equity line of credit' (HELOC)?
- A fixed-rate second mortgage paid out in a lump sum
- A revolving line of credit secured by the borrower's home equity that can be drawn and repaid repeatedly (Correct answer)
- A government program for first-time homebuyers
- A loan to cover closing costs on a new mortgage
Correct answer: A revolving line of credit secured by the borrower's home equity that can be drawn and repaid repeatedly
A HELOC is a revolving credit line secured by home equity, allowing borrowers to draw funds up to a set limit during a draw period and repay them, similar to a credit card.
Question 6: What is 'amortization' in the context of a mortgage?
- The process of refinancing a loan to get a lower interest rate
- The gradual repayment of a loan through scheduled payments that cover both principal and interest (Correct answer)
- The appreciation of a home's value over the life of the loan
- The process of transferring a mortgage from one lender to another
Correct answer: The gradual repayment of a loan through scheduled payments that cover both principal and interest
Amortization is the process by which a loan is paid off over time through regular payments that are allocated between principal reduction and interest charges.
Question 7: What is a 'non-conforming loan'?
- A mortgage with an unusual repayment schedule
- A mortgage that does not meet the guidelines set by Fannie Mae or Freddie Mac for purchase (Correct answer)
- A loan made without a formal appraisal
- A mortgage issued without PMI requirements
Correct answer: A mortgage that does not meet the guidelines set by Fannie Mae or Freddie Mac for purchase
Non-conforming loans fail to meet Fannie Mae or Freddie Mac purchase guidelines—typically due to loan size (jumbo), borrower creditworthiness, or non-standard property types.
Mortgage Terms 3
What is an 'escrow account' in mortgage servicing?