Title: Loans And Amortization — LearnCoachAssist

Q: What is a loan?
A: A loan is a sum of money borrowed from a lender that must be repaid over time, usually with interest. The borrower agrees to specific terms including the repayment schedule, interest rate, and any fees.

Q: What is the principal of a loan?
A: The principal is the original amount of money borrowed, before interest is applied. Each payment you make typically reduces the principal balance while also covering interest charges.

Q: What is interest on a loan?
A: Interest is the cost of borrowing money, expressed as a percentage of the principal. It is the fee the lender charges for providing the loan and is how lenders profit from lending.

Q: What is simple interest?
A: Simple interest is calculated only on the original principal throughout the life of the loan. The formula is \[I = P \times r \times t\] where \(P\) is principal, \(r\) is the rate, and \(t\) is time in years.

Q: What is compound interest?
A: Compound interest is calculated on both the initial principal and on the accumulated interest from previous periods. This causes interest to grow exponentially over time, dramatically increasing the total cost of borrowing.

Q: What is a mortgage?
A: A mortgage is a loan specifically used to purchase real estate, where the property itself serves as collateral. If the borrower fails to repay, the lender can foreclose on the property.

Q: What is a fixed-rate mortgage?
A: A fixed-rate mortgage has the same interest rate for the entire loan term, resulting in identical monthly payments. Common terms are 15, 20, or 30 years, providing predictable payments but often starting with higher rates than ARMs.

Q: What is an adjustable-rate mortgage (ARM)?
A: An ARM has an interest rate that changes periodically based on a benchmark index plus a margin. Initial rates are typically lower than fixed-rate loans, but payments can increase significantly when rates reset.

Q: What is an amortization schedule?
A: An amortization schedule is a table that breaks down each loan payment into principal and interest portions. It shows how the balance decreases over time and the total interest paid over the life of the loan.

Q: What does amortization mean in lending?
A: Amortization refers to the process of spreading loan payments over time so that the loan is fully repaid by the end of the term. Each payment includes both interest and principal, with the principal portion growing over time.

Q: What is the APR (Annual Percentage Rate)?
A: APR represents the yearly cost of borrowing money, including the interest rate plus certain fees like origination or closing costs. It expresses the true cost of a loan as a standardized annual rate for comparison purposes.

Q: What is the APY (Annual Percentage Yield)?
A: APY is the effective annual rate of return or cost after accounting for the compounding of interest within the year. It is most commonly used for savings accounts but also reflects the true cost of compounding on loans.

Q: What is the key difference between APR and APY?
A: Both describe an annual rate but they include different things. APY (effective annual rate) takes a nominal rate and accounts for intra-year compounding, so APY ≥ the nominal rate whenever interest compounds more than once a year. APR on a loan is a simple annual rate that ignores intra-year compounding but does fold in fees such as points and origination costs. So APR exceeds the nominal rate when fees are large, and a fee-loaded mortgage APR can be higher than the APY implied by the same note rate — they are not simply ranked.

Q: When does APY matter more than APR for borrowers?
A: APY matters most when comparing loans where compounding frequency varies, since it reflects the actual cost of interest being added back to the balance. Two loans with the same APR but different compounding schedules will have different APYs.

Q: When does APR matter more than APY for borrowers?
A: APR matters most when comparing loan offers with different fees and structures, because it includes closing costs and other charges. This makes it the standard for fair comparison of mortgage and loan offers.

Q: What is the formula for compound interest?
A: The compound interest formula is \[A = P\left(1 + \frac{r}{n}\right)^{nt}\] where \(A\) is the final amount, \(P\) is principal, \(r\) is the annual rate, \(n\) is compounding periods per year, and \(t\) is years.

Q: How is the monthly mortgage payment calculated?
A: The standard formula is \[M = P \cdot \frac{r(1+r)^n}{(1+r)^n - 1}\] where \(M\) is monthly payment, \(P\) is loan principal, \(r\) is monthly interest rate (annual rate ÷ 12), and \(n\) is total number of payments.

Q: Why do early mortgage payments consist mostly of interest?
A: Interest is calculated on the remaining balance, which is highest at the start of the loan. Early payments cover mostly interest because the balance is large; as the balance shrinks, more of each payment goes toward principal.

Q: How does loan term length affect total interest paid?
A: Longer terms mean smaller monthly payments but significantly more total interest paid. For example, a 30-year mortgage can cost 2-3 times more in total interest than a 15-year mortgage of the same amount.

Q: How do extra payments affect loan amortization?
A: Extra payments reduce the principal balance directly, which lowers the interest calculated on future payments. This shortens the loan term substantially and can save thousands in total interest, especially early in the loan.

Q: What are closing costs on a mortgage?
A: Closing costs are fees paid at the closing of a mortgage loan, typically 2-5% of the loan amount. They include appraisal fees, title insurance, origination fees, attorney fees, and prepaid items like property taxes and homeowners insurance.

Q: What are discount points on a mortgage?
A: Discount points are upfront fees paid to the lender at closing to reduce the mortgage interest rate. Each point costs 1% of the loan amount; the rate reduction it buys varies by lender and market conditions, commonly somewhere around an eighth to a quarter of a percentage point. It is a trade-off between upfront cost and long-term savings, and only pays off if you keep the loan long enough.

Q: What is PMI (Private Mortgage Insurance)?
A: PMI is insurance that protects the lender if the borrower defaults, typically required when the down payment is less than 20% of the home's value. It usually costs 0.5% to 2% of the loan annually and can be removed once sufficient equity is built.

Q: What is an escrow account on a mortgage?
A: An escrow account holds funds collected with monthly mortgage payments to pay property taxes and homeowners insurance when due. The lender manages the account and pays these bills on the borrower's behalf, ensuring they are never missed.

Q: What is a refinance?
A: Refinancing replaces an existing loan with a new one, usually to obtain a lower interest rate, change the loan term, or convert equity to cash. It involves closing costs and resets the amortization schedule from the beginning.

Q: When does refinancing typically make financial sense?
A: Refinancing makes sense when the new rate is at least 0.5-1% lower than the current rate, and you plan to stay long enough to recoup closing costs. A common rule is to keep the loan long enough to break even on the refi costs, typically 2-3 years.

Q: What are prepayment penalties?
A: Prepayment penalties are fees charged to borrowers who pay off a loan early or make large extra payments. They protect lenders from losing expected interest income and are more common in mortgages originated before 2014 and on some non-conforming loans.

Q: What is a balloon payment?
A: A balloon payment is a large lump-sum payment due at the end of a loan term after smaller periodic payments. Balloon loans have low monthly payments but require refinancing or a large cash payment at maturity, which can be risky.

Q: What is the Rule of 78?
A: The Rule of 78 (sum-of-the-digits method) front-loads interest so early payments contain disproportionately more interest than a simple-interest loan would charge. For an n-payment loan the digits 1 through n are summed as \(\frac{n(n+1)}{2}\) — for a 12-month loan that sum is 78, hence the name. Month 1 is charged 12/78 of total interest, month 2 charges 11/78, and so on, so paying off early saves far less interest than expected. It is banned or restricted for most consumer loans in the US.

Q: How does compounding frequency affect loan cost?
A: More frequent compounding means interest is added to the principal more often, leading to higher total interest. Daily compounding costs more than monthly, which costs more than annual, even with the same stated APR.

Q: How do you convert APR to APY?
A: Use the formula: \[APY = \left(1 + \frac{APR}{n}\right)^n - 1\] where \(n\) is the number of compounding periods per year. For monthly compounding on a 6% APR: APY ≈ 6.168%.

Q: What is the nominal interest rate?
A: The nominal interest rate is the stated rate without accounting for compounding or fees. It differs from the effective rate (APY) which includes compounding effects, and from APR which includes certain fees.

Q: What does total cost of a mortgage include?
A: Total mortgage cost includes the principal borrowed plus all interest paid over the loan's life, closing costs, mortgage insurance, property taxes, homeowners insurance, and maintenance. On a 30-year loan at typical rates the payments alone total roughly twice the amount borrowed, so the interest component is comparable to the loan itself.

Q: How should borrowers compare loan offers?
A: Compare offers using APR for total cost with fees, loan term, total interest paid, and monthly payment. Look beyond the rate to points, closing costs, and whether the rate is fixed or adjustable before deciding.

Q: What is amortization in accounting?
A: In accounting, amortization is the systematic expensing of an intangible asset's cost over its useful life. This is different from loan amortization, though the same word is used. Loan amortization refers to paying off debt through scheduled payments.

Q: What is negative amortization?
A: Negative amortization occurs when loan payments are less than the interest accruing, causing the unpaid interest to be added to the principal balance. This makes the loan balance grow over time despite making payments, common in some ARMs and option ARMs.

Q: What is an interest-only loan?
A: An interest-only loan requires payments covering only interest for a set period, typically 5-10 years. After this period, payments rise sharply because the full principal must be amortized over the remaining, shorter term — commonly a 40-60% jump on a 30-year loan with a 10-year interest-only period.

Q: What is the difference between a loan and a line of credit?
A: A loan provides a lump sum that is repaid on a fixed schedule, while a line of credit provides a borrowing limit you can draw from as needed. Lines of credit only charge interest on the amount drawn and offer more flexibility.

Q: What is a HELOC (Home Equity Line of Credit)?
A: A HELOC is a revolving credit line secured by your home's equity, typically functioning like a credit card with a draw period of 10 years. During the draw period, you usually pay interest only on the amount borrowed.

Q: What is the loan-to-value (LTV) ratio?
A: LTV ratio compares the loan amount to the property's appraised value, calculated as \[LTV = \frac{Loan\,Amount}{Property\,Value} \times 100\]. Higher LTV means greater lender risk, often requiring PMI above 80%.

Q: How does credit score affect loan terms?
A: Higher credit scores generally qualify borrowers for lower interest rates, saving tens of thousands over a loan's life. A score difference of just 100 points can change a mortgage rate by 0.5% or more, equating to tens of thousands in interest.

Q: What is the debt-to-income (DTI) ratio?
A: DTI ratio is the percentage of gross monthly income that goes toward debt payments, calculated as \[DTI = \frac{Monthly\,Debt\,Payments}{Gross\,Monthly\,Income} \times 100\]. Lenders typically prefer DTI below 36%, with 43% as the maximum for qualified mortgages.

Q: What is a jumbo loan?
A: A jumbo loan exceeds the conforming loan limit set annually by the Federal Housing Finance Agency (a figure in the high six figures for most US areas, higher in designated high-cost counties). These loans carry stricter underwriting and often higher rates because they cannot be purchased by Fannie Mae or Freddie Mac. Check the current year's limit, as it is reset every year.

Q: What is an amortized loan?
A: An amortized loan is fully repaid through equal periodic payments over a set term, with each payment covering both principal and interest. The payment stays the same, but the principal/interest split shifts gradually until the balance reaches zero.

Q: What is the break-even point on a refinance?
A: The break-even point is when accumulated monthly savings equal the refinance closing costs. Calculate it as \[Break\,Even = \frac{Closing\,Costs}{Monthly\,Savings}\] in months. If you plan to stay beyond this point, refinancing is generally worthwhile.

Q: What are origination fees?
A: Origination fees are charged by lenders to process a new loan application, typically 0.5% to 1% of the loan amount. They cover underwriting, processing, and administrative costs, and are usually part of the APR calculation.

Q: What is a 15-year vs 30-year mortgage trade-off?
A: A 15-year mortgage has higher monthly payments but much less total interest, often building equity faster. A 30-year offers lower monthly payments and more cash flow flexibility but costs significantly more in total interest paid.

Q: What is the opportunity cost of mortgage interest?
A: Opportunity cost refers to the investment returns foregone by spending money on interest instead of investing. Paying down a low-interest mortgage early may yield less than investing the difference in the market, depending on expected returns.

Q: What are the true components of borrowing cost?
A: True borrowing cost includes the interest rate, compounding frequency, fees, insurance, opportunity cost, and inflation effects. Looking only at the interest rate ignores fees that can add 0.1-0.5% to a loan's effective cost.

Q: What is amortization's effect on equity building?
A: Each principal payment increases homeowner's equity, which is the difference between property value and loan balance. Equity builds slowly with long-term loans because early payments mainly cover interest, slowing wealth accumulation.

Q: What strategy minimizes the true cost of interest?
A: Strategies include making extra payments toward principal, choosing shorter loan terms, biweekly instead of monthly payments, refinancing when rates drop, and comparing offers using APR rather than just the base rate. Even small extra payments early can save tens of thousands.

Q: What is an amortization table and how do you read it?
A: An amortization table is a row-by-row breakdown of each loan payment, showing how much goes to interest, how much to principal, and the remaining balance. Early rows show mostly interest, while later rows show increasingly more principal. It helps borrowers see exactly how their loan balance declines over time.

Q: What is PITI and why does it matter for homeowners?
A: PITI stands for Principal, Interest, Taxes, and Insurance — the four components of a typical monthly housing payment. Lenders use PITI to calculate debt-to-income ratios and qualify borrowers. Homeowners should budget for full PITI, not just the loan payment.

Q: What is the difference between origination points and discount points?
A: Origination points (typically 1% of the loan each) are fees charged by the lender to process and underwrite the loan. Discount points are prepaid interest that lower the loan's interest rate in exchange for an upfront fee. Both are usually expressed as "points" (1 point = 1% of the loan amount).

Q: What is the conforming loan limit?
A: The conforming loan limit is the maximum loan size that Fannie Mae and Freddie Mac will purchase from lenders, set annually by the Federal Housing Finance Agency. Loans above this limit are classified as jumbo loans and typically carry stricter underwriting and higher rates.

Q: What are FHA loans and who do they serve?
A: FHA loans are mortgages insured by the Federal Housing Administration, designed for borrowers with lower credit scores or smaller down payments. They allow down payments as low as 3.5% but require both an upfront and ongoing mortgage insurance premium (MIP).

Q: What are VA loans and what is their key benefit?
A: VA loans are mortgages guaranteed by the U.S. Department of Veterans Affairs, available to eligible military service members, veterans, and their families. Their key benefit is requiring no down payment and no private mortgage insurance, often with competitive interest rates.

Q: What are common predatory lending practices?
A: Predatory lending includes tactics like excessive fees, inflated interest rates, loan flipping, packing unnecessary features, steering borrowers into higher-cost products, and targeting vulnerable populations. Borrowers should compare multiple offers and read all disclosures carefully.

Q: What does the Truth in Lending Act (TILA) require?
A: TILA requires lenders to disclose key credit terms — including APR, total finance charges, and payment schedule — in a standardized format. It gives consumers the right to cancel certain credit transactions within a 3-day rescission period and protects against inaccurate billing.

Q: What is the amortization formula for a fixed-payment loan?
A: \[M = P \cdot \frac{r(1+r)^n}{(1+r)^n - 1}\]
where M = monthly payment, P = principal, r = monthly interest rate (annual rate ÷ 12), and n = total number of payments.

Q: What is a reverse mortgage and who is it designed for?
A: A reverse mortgage allows homeowners aged 62+ to convert home equity into cash. The lender pays the borrower, and the loan balance grows over time, repaid when the borrower sells, moves out, or passes away.

Q: What is a construction loan?
A: A short-term loan used to finance the building of a home or property. It typically converts into a permanent mortgage once construction is complete, and funds are disbursed in stages (draws) as construction milestones are met.

Q: What is a bridge loan?
A: A short-term loan (usually 6–12 months) that "bridges" the gap between buying a new home and selling an existing one. It uses the current home's equity as collateral and often carries higher interest rates.

Q: What is a USDA loan?
A: A government-backed mortgage for low-to-moderate-income buyers in eligible rural areas. It offers 0% down payment and reduced mortgage insurance costs, administered by the U.S. Department of Agriculture.

Q: What are the rate caps on an adjustable-rate mortgage?
A: ARMs typically have three caps: an initial cap (limit on the first adjustment), a periodic cap (limit on each subsequent adjustment, often 1–2%), and a lifetime cap (maximum rate increase over the loan's life).

Q: What is the index and margin on an ARM?
A: The index (e.g., SOFR or Treasury rate) is the benchmark the rate is tied to, and the margin is a fixed percentage added by the lender. Together: ARM rate = index + margin.

Q: What is a 2-1 buydown mortgage?
A: A temporary buydown where the interest rate is 2% lower in year one and 1% lower in year two, then steps up to the permanent rate in year three. The borrower prepays the difference upfront or via seller/builder credits.

Q: What is a rate lock?
A: A lender's commitment to hold a specific interest rate for a set period (typically 30–60 days) while the loan is processed. It protects the borrower from rate increases before closing.

Q: What is a cash-out refinance?
A: A refinance where the new mortgage is larger than the existing balance, and the borrower receives the difference in cash. It converts home equity into liquid funds but resets the amortization schedule.

Q: What is a no-closing-cost refinance?
A: A refinance where the lender pays closing costs in exchange for a slightly higher interest rate. The borrower avoids upfront fees but pays more interest over the loan's life.

Q: What is a piggyback loan (80-10-10)?
A: A strategy combining a first mortgage (80% LTV), a second mortgage or HELOC (10% LTV), and a 10% down payment. It allows the borrower to avoid PMI on the primary loan.

Q: What are seller concessions?
A: Costs the home seller agrees to pay on behalf of the buyer at closing, such as origination fees or points. Concession limits are set by loan type (e.g., typically 3–6% for conventional loans).

Q: What is the Loan Estimate?
A: A standardized three-page form lenders must provide within three business days of a mortgage application. It discloses loan terms, projected payments, closing costs, and key comparisons to help borrowers shop.

Q: What is the Closing Disclosure?
A: A final five-page form provided at least three business days before closing. It itemizes the loan terms, monthly payments, closing costs, and cash to close, allowing the borrower to compare with the Loan Estimate.

Q: What does TRID require lenders to do?
A: TRID (TILA-RESPA Integrated Disclosure) requires lenders to provide both the Loan Estimate and Closing Disclosure with specific timing rules, helping borrowers understand costs and compare loan offers clearly.

Q: What is the right of rescission?
A: Federal law gives borrowers three business days after closing to cancel a refinance or home equity loan (not purchase loans) without penalty, as protection against predatory lending.

Q: What is yield spread premium (YSP)?
A: Compensation a loan originator receives from a lender for charging a borrower an interest rate above the par rate. It can create a conflict of interest, since higher rates yield higher YSP for the originator.

Q: What is title insurance?
A: Insurance that protects the lender (and optionally the buyer) against financial loss from defects in the property title, such as liens, easements, or ownership disputes that weren't found during the title search.

Q: What is hazard insurance?
A: Homeowners insurance covering the structure against risks like fire, wind, and theft. Lenders require it to protect their collateral, and premiums are often paid through an escrow account.

Q: How does the foreclosure process generally work?
A: After missed payments, the lender issues a notice of default, then a notice of sale. If the borrower doesn't cure, the property is auctioned. Judicial foreclosure requires court approval; non-judicial follows deed-of-trust terms.

Q: What is a short sale?
A: A sale of a home for less than the outstanding mortgage balance, with the lender's approval. The borrower avoids foreclosure but typically faces credit damage and may owe the remaining balance (deficiency).

Q: What is a deed in lieu of foreclosure?
A: An arrangement where the borrower voluntarily transfers ownership of the property to the lender to satisfy the debt, avoiding the formal foreclosure process. Lenders may still pursue deficiency balances.

Q: What is forbearance?
A: A temporary pause or reduction in mortgage payments granted by the lender during financial hardship. The borrower must repay the deferred amounts later, often as a lump sum or through a modified payment plan.

Q: What is loan modification?
A: A permanent change to the original loan terms—such as a lower rate, extended term, or principal reduction—to make payments more affordable for a struggling borrower and avoid foreclosure.

Q: What is the statute of limitations on debt collection?
A: A time limit (varies by state, typically 3–10 years) after which a creditor can no longer sue to collect an unpaid debt. It doesn't erase the debt but restricts legal enforcement actions.

Q: How does inflation affect the true cost of borrowing?
A: Inflation erodes the real value of future loan payments, effectively lowering the real cost of borrowing for fixed-rate loans. Borrowers repay with "cheaper" dollars, while lenders receive less purchasing power back.

Q: What is the difference between real and nominal interest rates?
A: The nominal rate is the stated rate; the real rate adjusts for inflation: real rate ≈ nominal rate − inflation rate. Only the real rate reflects the true cost of borrowing.

Q: What is the Fisher equation?
A: \[(1 + i) = (1 + r)(1 + \pi)\]
where i = nominal rate, r = real rate, and π = inflation. Approximately: nominal rate ≈ real rate + inflation.

Q: What is continuous compounding?
A: Interest compounded infinitely often, calculated as \(A = Pe^{rt}\). It's the theoretical maximum compounding frequency and is sometimes used for precise APR/APY comparisons between products.

Q: How does payment frequency affect total interest paid?
A: More frequent payments (e.g., biweekly instead of monthly) reduce the outstanding principal faster, which means less interest accrues between payments and total interest over the loan's life decreases.

Q: What is a biweekly mortgage payment plan?
A: Paying half the monthly payment every two weeks, resulting in 26 half-payments (13 full payments) per year instead of 12. This extra annual payment shortens a 30-year loan by roughly 4–6 years.

Q: What is loan recasting?
A: After making a large lump-sum payment toward the principal, the lender re-amortizes the remaining balance over the existing term at the same rate, which lowers the monthly payment but doesn't change the loan duration.

Q: What is an assumable mortgage?
A: A mortgage that allows a buyer to take over the seller's existing loan terms—including rate and balance. Common with FHA, VA, and USDA loans, valuable when current rates are higher than the assumed rate.

Q: What is a promissory note?
A: A written, signed promise to repay a specific amount of money under agreed terms (rate, term, payment schedule). It's the personal obligation to pay; the mortgage is the security instrument tied to the property.

Q: What is the difference between a promissory note and a mortgage?
A: The note is the borrower's promise to repay the debt. The mortgage (or deed of trust) is the security instrument giving the lender a lien on the property if the note isn't repaid.

Q: What is subordination in lending?
A: The process of changing the priority of liens on a property. A junior lien can be "subordinated" to a new primary mortgage (with lender consent), preserving the new first-lender's priority position.

Q: What is an acceleration clause?
A: A contract provision allowing the lender to demand immediate full repayment of the loan balance if the borrower defaults, such as by missing multiple payments or violating other terms.

Q: What is a due-on-sale clause?
A: A mortgage provision requiring the loan to be fully repaid when the property is sold or transferred. It prevents loan assumptions unless the lender specifically approves them.

Q: What is the debt service coverage ratio (DSCR)?
A: A metric (especially for commercial loans) comparing a property's net operating income to its debt obligations: \(DSCR = NOI / Debt Service\). Lenders generally require DSCR ≥ 1.2.

Q: What is yield to maturity (YTM)?
A: The total annualized return an investor earns by holding a bond or loan until it matures, accounting for coupon payments and any gain/loss relative to face value. It reflects the true yield on a fixed-income investment.

Q: What are mortgage-backed securities (MBS)?
A: Financial instruments that pool together many mortgages and sell shares of the cash flows to investors. MBS increase liquidity in the mortgage market and were central to the 2008 financial crisis.

Q: What is the role of Fannie Mae and Freddie Mac?
A: Government-sponsored enterprises that buy mortgages from lenders, package them into MBS, and provide liquidity to the mortgage market. They set conforming loan standards and are key to affordable home financing.

Q: What is a sinking fund?
A: A fund built up over time by periodic deposits to pay off a future obligation, such as a bond maturity. In lending, similar to an escrow account where money is accumulated for a specific future payment.

Q: What is the effective annual rate (EAR) formula?
A: \[EAR = \left(1 + \frac{r}{n}\right)^n - 1\]
where r = nominal rate and n = compounding periods per year. EAR is equivalent to APY and reveals the true annual cost of credit.

Q: What is a payday loan and why is it expensive?
A: A short-term, high-cost loan secured by the borrower's next paycheck. APRs can exceed 400% because fees are flat per $100 borrowed over a two-week period, translating to astronomical annualized rates.

Q: How does credit card interest differ from mortgage interest?
A: Credit cards typically compound daily (365 times/year), carry variable rates of 20–30%, and have no amortization schedule. Mortgages compound monthly, are much lower, and amortize principal over a fixed term.

Q: What is the net present value (NPV) of a loan?
A: The sum of all loan payments discounted back to today's dollars. A positive NPV (to the lender) means the loan earns more than the discount rate; NPV helps compare loans of different terms and rates.

Q: What is a margin loan?
A: A loan from a brokerage that uses the borrower's investment portfolio as collateral. Interest rates are typically low, but if the portfolio value drops below a threshold, the broker can issue a margin call requiring more funds.

Q: What is amortization in the context of business loans?
A: Businesses amortize intangible assets (like patents or goodwill) over their useful life for accounting and tax purposes. This is different from loan amortization, though the term and mathematical concept are similar.

Q: What is an amortizing bond vs. a bullet bond?
A: An amortizing bond repays principal gradually over its life. A bullet bond repays the entire principal at maturity, making it similar to a balloon-payment structure from the borrower's perspective.

Q: What is a cosigner and how do they affect a loan?
A: A cosigner pledges to repay the loan if the primary borrower defaults. Cosigners don't access the funds but share full legal liability, and the loan appears on their credit report, affecting their borrowing capacity.

Q: What is debt covenant in a loan agreement?
A: A condition borrowers must maintain—like minimum liquidity ratios or limits on additional debt. Violating a covenant can trigger penalties, higher interest rates, or default, giving lenders protection during the loan term.

Q: What is a graduated payment mortgage (GPM)?
A: A GPM starts with lower-than-normal payments that gradually increase (usually for 5-10 years) before leveling off to a fully amortizing payment. This structure helps borrowers who expect rising income but can lead to negative amortization during the early years.

Q: What is a growing equity mortgage (GEM)?
A: A GEM keeps the monthly payment constant, but a portion is applied directly to principal reduction, accelerating equity buildup. Borrowers effectively pay off the loan faster than with a standard fixed-rate mortgage of the same nominal term.

Q: What is the difference between simple interest and precomputed interest on a loan?
A: Simple interest loans calculate interest each period on the current outstanding (declining) balance. Precomputed interest loans calculate the total interest upfront at origination and bake it into the schedule, so paying off early yields little to no interest savings.

Q: What is a self-amortizing loan?
A: A self-amortizing loan is structured so that level periodic payments fully retire both principal and interest over the loan term, leaving a zero balance at maturity. Most standard fixed-rate mortgages (15- or 30-year) are self-amortizing.

Q: What is straight-line amortization?
A: Straight-line amortization divides total interest evenly across all payment periods rather than front-loading it like the standard actuarial method. It is rare in mortgages but common in some consumer and business installment loans.

Q: What is a curtailment on a mortgage?
A: A curtailment is any payment that reduces the principal balance beyond the scheduled amount, such as extra monthly payments or a lump sum. Each curtailment lowers the outstanding balance and reduces total interest paid over the loan's life.

Q: What is the 30/360 day count convention?
A: The 30/360 convention assumes every month has 30 days and a year has 360 days when calculating accrued interest. Over a full year it charges essentially the same total as actual/365, but it evens out month-to-month accrual so every month accrues identically. Do not confuse it with actual/360, which charges actual days at a rate divided by 360 and therefore genuinely raises the effective rate.

Q: What is the actual/365 day count convention?
A: Under actual/365, interest accrues based on the actual number of days in each month divided by 365. It produces a slightly different interest charge than 30/360, especially in months with 31 days or February.

Q: What is the mortgage constant?
A: The mortgage constant is the annual debt service (total yearly payment) divided by the loan principal, expressed as a percentage. It is used in real estate underwriting to compare financing costs: \[ MC = \frac{\text{Annual Payment}}{\text{Loan Amount}} \]

Q: What is the internal rate of return (IRR) on a mortgage?
A: The IRR is the discount rate that sets the net present value of all loan payments equal to the net proceeds received by the borrower. It captures the true effective cost of the loan, including fees, points, and compounding.

Q: What is payment shock on an ARM?
A: Payment shock is the sudden, often large increase in the monthly payment when an adjustable-rate mortgage resets to a new rate or begins amortizing. It can cause severe financial strain if the borrower didn't plan for higher payments.

Q: What is an option ARM?
A: An option ARM lets the borrower choose among several monthly payment options, including minimum, interest-only, 30-year amortizing, or 15-year amortizing. Choosing the minimum payment can lead to negative amortization and a growing loan balance.

Q: What is deferred interest on a loan?
A: Deferred interest accrues during a promotional period but isn't paid immediately; if the balance isn't paid in full by the deadline, the accrued interest is added to the principal ("kicks in"). This can dramatically raise the true cost of "no interest" financing offers.

Q: What is add-on interest?
A: Add-on interest is computed once on the full original principal for the entire loan term and then added to the principal before dividing into equal payments. This method produces a much higher effective interest rate than the stated rate suggests.

Q: How does amortization differ from depreciation for tax purposes?
A: Amortization spreads the cost of intangible assets or loan principal over time, while depreciation spreads the cost of tangible assets. For homeowners, mortgage interest (not amortization of principal) is the typically tax-deductible component.

Q: What is interest capitalization?
A: Interest capitalization occurs when unpaid accrued interest is added to the loan principal, causing future interest to be calculated on a larger balance. It magnifies the true cost of borrowing, especially with deferred payments or negative amortization.

Q: What is a pro rata prepayment?
A: A pro rata prepayment pays off a proportionate share of the loan balance across all maturities or tranches, rather than retiring the earliest or largest balances first. This method is common in mortgage-backed securities but rarely available to individual borrowers.

Q: What is the FHA mortgage insurance premium (MIP)?
A: The FHA MIP is an insurance fee charged by the Federal Housing Administration on FHA loans to protect lenders against default. It typically includes an upfront premium (1.75% of the loan) plus annual premiums, and usually remains for the loan's life if the down payment is under 10%.

Q: What is the VA funding fee?
A: The VA funding fee is a one-time charge paid to the Department of Veterans Affairs on VA-backed loans, ranging from about 1.25% to 3.3% of the loan amount. It funds the VA loan program, can be rolled into the loan, and may be waived for disabled veterans.

Q: What is the difference between recurring and non-recurring closing costs?
A: Recurring closing costs (like property taxes, homeowners insurance, and prepaid interest) are ongoing expenses that repeat. Non-recurring closing costs (like origination fees, title insurance, and appraisal fees) are one-time charges paid at closing.

Q: What is the long-term consequence of negative amortization?
A: Negative amortization means the borrower owes more than the original loan amount after years of payments, dramatically increasing the true cost of interest. It delays equity building and creates a much larger balance to repay or refinance later.

Q: How does daily compounding affect credit card borrowing costs?
A: Credit cards typically compound interest daily on the average daily balance, so unpaid balances grow geometrically rather than linearly. A 20% APR compounded daily produces an effective annual rate higher than 20%, significantly raising the true cost of carrying a balance.

Q: What is the net effective borrowing rate?
A: The net effective borrowing rate is the loan's interest rate adjusted for tax deductibility, fees, and compounding frequency. For a home equity loan where interest is deductible, the net rate may be substantially lower than the stated APR.

Q: What is the Total Interest Percentage (TIP)?
A: TIP is a disclosure that shows the total interest a borrower will pay over the loan's life as a percentage of the loan amount. Required by the TILA-RESPA Integrated Disclosure rule, it helps borrowers compare offers more clearly than APR alone.

Q: Why is APY standardized under US law?
A: US regulations (Regulation DD and the Truth in Savings Act) require institutions to quote APY uniformly so consumers can compare deposit products across banks. Standardization mandates a specific formula and compounding assumption, eliminating misleading rate displays.

Q: What is the difference between a discount rate and an interest rate?
A: The interest rate is the cost of borrowing money expressed as a periodic rate, while the discount rate is typically the rate used to determine the present value of future cash flows, often by a central bank or in NPV calculations.

Q: What is a credit spread on a loan?
A: The credit spread is the additional interest rate a borrower pays above a benchmark rate (like prime or Treasury) to compensate the lender for credit risk. Borrowers with weaker credit pay wider spreads above the base rate.

Q: What is SOFR?
A: SOFR (Secured Overnight Financing Rate) is a benchmark interest rate based on overnight Treasury-backed repurchase agreements, replacing LIBOR as the primary US dollar reference rate. It underpins many adjustable-rate loans, ARMs, and commercial mortgages.

Q: Why was LIBOR replaced as a benchmark rate?
A: LIBOR was phased out due to scandal-driven rate manipulation concerns and a decline in the underlying interbank lending market it measured. SOFR, based on actual overnight secured transactions, is considered more reliable and harder to manipulate.

Q: What is the prime rate and who sets it?
A: The prime rate is the interest rate banks charge their most creditworthy commercial customers, typically published by The Wall Street Journal based on a survey of major banks. Most variable-rate consumer loans (HELOCs, credit cards) are priced as prime plus a margin.

Q: What is the federal funds rate?
A: The federal funds rate is the interest rate at which US banks lend reserves to each other overnight, set by the Federal Reserve's Federal Open Market Committee. It influences virtually all other rates in the economy, including mortgage rates and credit card APRs.

Q: How does tax deductibility affect the true cost of mortgage borrowing?
A: Homeowners who itemize can deduct mortgage interest, reducing the effective borrowing cost by their marginal tax rate. For someone in the 24% bracket, a 7% mortgage has an after-tax cost closer to about 5.3%, dramatically lowering the true cost of interest.

Q: What is the mortgage interest deduction cap?
A: For mortgages taken out after December 15, 2017, taxpayers can deduct interest on up to $750,000 of qualified mortgage debt ($375,000 if married filing separately). Older mortgages remain subject to the previous $1,000,000 limit under grandfathering rules.

Q: How does the mortgage interest deduction lower the effective borrowing cost?
A: If your marginal tax rate is 22% and your mortgage rate is 6%, the tax savings reduce the effective interest rate to about \(6\% \times (1 - 0.22) = 4.68\%\). The true cost falls proportionally to your tax bracket, but only for borrowers who itemize.

Q: What is debt service?
A: Debt service is the total cash required over a given period to cover interest and principal payments on outstanding debt. Lenders use the debt service coverage ratio (DSCR) to assess a borrower's ability to repay from operating cash flow, especially in commercial lending.

Q: When does debt consolidation make financial sense?
A: Debt consolidation makes sense when you can secure a lower interest rate, simplify payments, and commit to not accruing new debt. It often works best when consolidating high-interest credit card balances into a lower-rate personal loan, HELOC, or balance transfer card.

Q: What is a balance transfer?
A: A balance transfer moves high-interest credit card debt to a new card offering a lower introductory APR (often 0% for 12-21 months). It can save significant interest, but transfer fees (typically 3-5%) and post-promotional rates affect the true cost.

Q: How does inflation affect the lender's real return on a loan?
A: Inflation erodes the purchasing power of the dollars the borrower repays, so the lender's real return equals the nominal rate minus inflation. A 5% mortgage during 3% inflation yields only about 2% in real terms—an important consideration when calculating the true economic cost.

Q: What does the Rule of 72 indicate about high-rate debt?
A: The Rule of 72 estimates how long it takes a debt balance to double at a given interest rate by dividing 72 by the rate. At 18% APR (a typical credit card penalty rate), a balance doubles in just 4 years—a powerful illustration of high-rate borrowing costs.

Q: What is a shared appreciation mortgage (SAM)?
A: A SAM offers a below-market interest rate in exchange for sharing a percentage of the home's future appreciation with the lender. It lowers monthly payments but exposes the borrower to a share of any property value gains at sale or refinance.

Q: What is the combined loan-to-value (CLTV) ratio?
A: CLTV sums the balances of all loans secured by a property (first mortgage, second mortgage, HELOC) and divides by the property's value. It measures total lien exposure and is used by lenders to evaluate risk when multiple loans exist on one property.

Q: When is private mortgage insurance (PMI) typically required?
A: PMI is generally required on conventional loans when the down payment is less than 20% of the home's value (LTV exceeds 80%). It protects the lender if the borrower defaults, and the borrower pays the premium as a condition of the loan.

Q: When can PMI typically be cancelled on a conventional loan?
A: Under federal law, PMI must be cancelled automatically once LTV reaches 78% based on the original amortization schedule. Borrowers can also request cancellation at 80% LTV, provided the home value has not declined and the payment history is current.

Q: Why are early mortgage payments mostly interest?
A: In a fully amortizing loan, each payment covers interest on the current balance plus some principal reduction. Because the balance is highest at the start, the interest charge (balance × rate) is largest, so most of the early payment goes to interest rather than principal.

Q: What is the crossover point in a mortgage amortization?
A: The crossover point is the month when the principal portion of each payment first exceeds the interest portion. On a 30-year fixed loan it falls where roughly 139 payments remain at a 6% rate — about year 18 — and it moves earlier at lower rates (around year 13 at 4%) and later at higher rates. After the crossover, more of each payment builds equity than pays interest.

Q: How does home equity build up through amortization?
A: Equity grows as loan principal is paid down and as the property potentially appreciates. Scheduled principal payments steadily reduce the balance, and appreciation adds to the owner's stake. Equity buildup accelerates after the amortization crossover point.

Q: How do extra principal payments affect a mortgage?
A: Extra payments reduce the outstanding balance immediately, which lowers future interest charges. The result is a shorter loan term, lower total interest paid, and faster equity accumulation. Even small additional amounts can shave years off a 30-year mortgage.

Q: How do you read a standard amortization schedule?
A: Each row shows the payment number, payment amount, interest portion, principal portion, and remaining balance. The interest portion declines over time while the principal portion grows, and the ending balance reaches zero at the loan's maturity date.

Q: How do you build an amortization schedule by hand?
A: For each period: (1) calculate interest as beginning balance × periodic rate, (2) subtract interest from the fixed payment to get principal paid, (3) subtract principal from the balance to get the new balance. Repeat until the balance reaches zero.

Q: What does the PMT function calculate in a financial calculator?
A: The PMT function computes the fixed periodic payment needed to fully amortize a loan given the interest rate, number of periods, and principal. It assumes equal payments and a fully amortizing structure where the balance reaches zero at maturity.

Q: How do you calculate the remaining loan balance?
A: The remaining balance equals the present value of all remaining payments discounted at the loan's interest rate. It can also be computed iteratively by subtracting cumulative principal paid from the original loan amount over the elapsed periods.

Q: What is the payment structure of an interest-only mortgage?
A: During the initial interest-only period (often 5–10 years), the borrower pays only the interest that accrues each month, leaving the principal unchanged. After that period, payments jump to a fully amortizing level, often causing significant payment shock.

Q: How does a HELOC draw period work?
A: During the draw period (typically 10 years), the borrower can withdraw funds up to a credit limit and is usually required to make interest-only payments on the amount drawn. The balance fluctuates as the borrower draws and repays.

Q: How does a HELOC repayment period work?
A: After the draw period ends, the HELOC enters a repayment phase (often 10–20 years) where the borrower can no longer draw funds and must make fully amortizing payments that pay off both principal and interest by the end of the term.

Q: What is a balloon payment risk on a mortgage?
A: A balloon payment is a large lump sum due at the end of a loan that was not fully amortized. Borrowers face refinancing risk: they must obtain a new loan or pay the balance in cash when it comes due, which can be difficult in adverse market conditions.

Q: What is the refinancing breakeven period?
A: The breakeven period is the time required for monthly savings from a new lower rate to equal the upfront refinancing costs. Dividing total closing costs by monthly payment savings gives the months needed; staying in the loan beyond that point yields net savings.

Q: What is the difference between soft and hard prepayment penalties?
A: A soft prepayment penalty applies only when the loan is refinanced, not when the home is sold. A hard prepayment penalty applies in both cases, including sales. Hard penalties are far more restrictive and are largely prohibited on most residential mortgages.

Q: How does recasting differ from refinancing?
A: Recasting keeps the existing loan and rate but re-amortizes the remaining balance after a large principal payment, lowering the monthly payment. Refinancing replaces the loan with a new one, potentially at a different rate, with new closing costs and term.

Q: How does a shorter loan term affect total interest paid?
A: Shorter terms (e.g., 15 vs 30 years) carry lower rates and dramatically reduce total interest, sometimes by 50% or more. The trade-off is a higher monthly payment, since principal is amortized over far fewer periods.

Q: What is the lifetime cost of a mortgage?
A: The lifetime cost equals the total of all payments over the life of the loan: monthly payment × number of payments. Subtracting the original loan amount gives the total interest paid, the most visible measure of the true cost of borrowing.

Q: What types of fees are typically included in APR?
A: APR incorporates the interest rate plus many closing costs: origination fees, discount points, mortgage insurance premiums, underwriting fees, and certain other lender charges. It excludes items like title insurance and appraisal fees in many calculations.

Q: How do closing costs affect the disclosed APR?
A: When fees are financed into the loan or paid upfront, APR is higher than the nominal interest rate. Comparing APRs across loan offers approximates the true cost, since it spreads upfront fees over the life of the loan as an effective rate.

Q: What is the mathematical relationship between APY and nominal rate?
A: APY compounds the nominal rate within the year. For rate \(r\) compounded \(n\) times per year: \[\text{APY} = \left(1 + \frac{r}{n}\right)^n - 1\] More frequent compounding yields a higher APY.

Q: Why is APR always lower than APY for the same nominal rate?
A: APR does not reflect intra-year compounding; it is stated as a simple annual rate. APY accounts for compounding within the year, so it is always greater than or equal to the nominal rate, making APR appear lower even when the underlying nominal rate is identical.

Q: How should borrowers use APR to compare loan offers?
A: APR enables apples-to-apples comparison across lenders with different rates and fees. The offer with the lowest APR generally has the lowest total cost over the same term, assuming identical loan amounts, terms, and timing of fee payments.