P3-79 quiz

1. Question

Why are interest-only loans described as dangerous for borrowers who do not realize that the loan will convert after the initial period?

A) Because the interest-only period never ends, so their payment amount never changes.

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B) Because the lender automatically reduces the interest rate when the teaser period expires.

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C) Because they always build substantial equity regardless of whether they pay principal.

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D) Because when the teaser rate expires they may face a much higher payment and discover they have built no equity, leaving them with nothing if they sell.

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2. Question

A borrower takes an interest-only loan expecting a new, higher-paying job before the loan converts. The new job never materializes and their current job is eliminated. According to the text, what risk does this situation illustrate?

A) That the loan will automatically convert to a fixed rate at a lower payment.

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B) That the lender will be required to forgive any unpaid interest during the teaser period.

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C) That relying on a future job or refinance to afford the higher payment can become a disaster if income falls or rates rise.

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D) That the interest-only option can be extended indefinitely by the borrower.

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3. Question

How can falling housing prices create a serious problem for homeowners with interest-only loans who planned to sell before the loan converts?

A) Falling prices automatically reduce the principal balance owed on the mortgage.

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B) Falling prices guarantee that the lender will refinance at a lower rate.

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C) Falling prices allow the borrower to walk away from the mortgage without consequences.

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D) Falling prices can leave the mortgage balance higher than the home’s value, limiting refinance options and forcing some borrowers who can’t afford the new payment to default.

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4. Question

Which statement best describes how monthly payments are structured during the interest-only period of an interest-only mortgage?

A) Each payment includes both principal and interest from the first month of the loan.

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B) Payments consist only of interest for a specified period, usually 5 to 10 years, with no principal reduction.

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C) Payments start with principal only, and interest is deferred to the end of the loan.

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D) Payments alternate monthly between principal-only and interest-only amounts.

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5. Question

If a borrower has a 30-year mortgage with a 5-year interest-only period and pays only interest during that time, over what period will the principal then have to be amortized?

A) 30 years, because the term resets when the interest-only period ends.

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B) 15 years, since half the original term has elapsed.

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C) 10 years, equal to twice the interest-only period.

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D) 25 years, the remaining term after the 5-year interest-only period ends.

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6. Question

What happens to the unpaid principal balance if a borrower only makes interest payments during the entire interest-only period?

A) The principal balance does not decrease and must be repaid over the shorter remaining term once amortization begins.

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B) The principal balance is automatically reduced each year by the lender.

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C) The principal balance is forgiven at the end of the interest-only period.

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D) The principal balance is converted into a separate, unsecured personal loan.

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7. Question

In the example of the medical student in the text, why might an interest-only mortgage be an appropriate choice?

A) Because the student will never have to make payments that include principal.

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B) Because the interest rate is guaranteed to decrease once residency is completed.

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C) Because the loan converts automatically to a government grant after 10 years.

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D) Because it keeps near-term payments low while the student is in school, and expected higher future income should support the larger payments after the interest-only period.

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8. Question

According to the text, for which type of borrower can an interest-only mortgage be a “boon” despite its risks?

A) Borrowers who have no realistic prospect of increased income and want permanently low payments.

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B) Borrowers who expect home values to decline sharply and want to minimize their equity.

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C) Borrowers who can reasonably expect to make bigger payments later and are willing to trade near-term savings for higher future payments.

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D) Borrowers who intend to stop making payments once the interest-only period ends.

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