CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features

Mortgage Loan Types and Features for CFA Level I

Updated 7 October 2026 · Fact-checked

A mortgage loan is a loan secured by real estate. Key features are the rate type (fixed or adjustable), the amortization pattern, prepayment rights, recourse versus non-recourse, and loan-to-value (LTV = loan ÷ property value). To solve questions, identify the feature, then apply its rule or compute the payment, balance or LTV.

Understand Mortgage Loan Basics and Types

A mortgage loan is a loan to a borrower, secured by a specific piece of real estate. The property is the collateral. If the borrower stops paying, the lender can take the property through foreclosure and sell it. Lenders pool mortgage loans to create mortgage-backed securities, so the loan features drive the risk of the securities.

The interest rate can be fixed or adjustable. A fixed-rate mortgage keeps the same rate for the whole term. A payment on a fully amortizing fixed-rate loan stays level. An adjustable-rate mortgage (ARM) has a rate that resets periodically as a reference rate plus a margin. Often it has an initial fixed period and caps on how much the rate can change. The borrower carries the interest rate risk on an ARM. On a fixed-rate loan, the lender or investor bears more interest rate risk, because the value of the loan falls when market rates rise.

Amortization describes how principal is repaid. In a fully amortizing loan, each payment covers interest on the outstanding balance plus some principal, so the balance reaches zero at maturity. Early payments are mostly interest. Later payments are mostly principal. In a partially amortizing loan, a balance remains at maturity and is paid as a balloon payment. In an interest-only loan, the borrower pays only interest for a period, so the balance does not fall. Interest-only and balloon structures are more common in commercial loans.

A prepayment option lets the borrower pay off part or all of the loan early. Borrowers prepay when they sell the home or refinance after rates fall. This creates prepayment risk for investors. Some loans charge a prepayment penalty to discourage early payoff.

The loan is recourse if the lender can claim the borrower's other assets and income when the collateral sale does not cover the debt. It is non-recourse if the lender can look only to the property. The lender then bears more credit risk, and the borrower holds a type of default option: the borrower can give up the property and walk away from the debt. Loan-to-value (LTV) is the loan amount divided by the property's appraised value or purchase price. A lower LTV means a bigger borrower equity cushion and lower credit risk. Lenders also use debt-to-income (DTI): the borrower's debt payments relative to income.

Key formulas to remember

Loan-to-value ratio: LTV = Loan amount ÷ Property value; Lenders typically use the lower of appraised value and purchase price. Lower LTV means lower credit risk.
Down payment: Down payment = Property value − Loan amount; LTV = 1 − Down payment ÷ Property value; A 20% down payment means an 80% LTV.
Level mortgage payment: PMT = PV × r ÷ [1 − (1 + r)^−n]; r is the periodic rate (annual rate ÷ 12 for monthly) and n is the number of payments.
Interest in a period: Interest = Beginning balance × periodic rate; Principal repaid = Payment − Interest.
Ending balance: Ending balance = Beginning balance − Principal repaid; Use this to build each row of an amortization schedule.
ARM rate: Rate after reset = Reference rate + Margin; Subject to periodic and lifetime caps and floors, if the loan has them.

How to solve Mortgage Loan Basics and Types questions

Use this order for any question on mortgage loan features.

1Read what is asked: a feature definition, a risk comparison, or a number (payment, balance, interest, LTV).
2Identify the rate type: fixed or adjustable. Note any initial fixed period, caps or margin.
3Identify the amortization type: fully amortizing, partially amortizing with a balloon, or interest-only.
4Check recourse status and prepayment terms, since these decide who bears which risk.
5For numbers, convert to the periodic rate and number of periods first (monthly: annual rate ÷ 12, years × 12).
6Compute interest as beginning balance × periodic rate, then principal as payment minus interest, then the new balance.
7Compute LTV as loan ÷ property value, using the value the question specifies.
8Eliminate the two wrong options by checking direction: does your answer make sense for risk, size and sign?

Quickest way: Feature-to-risk shortcut and one-period schedule

When to use it: Use it when the question is conceptual or asks for first-period interest, principal or LTV.

Fixed rate: borrower has payment certainty. ARM: borrower bears rate risk.
Non-recourse: lender bears more credit risk. Recourse: borrower is more exposed.
Lower LTV: safer for the lender. Higher LTV: riskier.
Prepayment happens most when rates fall, which hurts investors holding the loan.
For period 1: interest = loan × periodic rate. Principal = payment − interest.
Check the answer: interest should fall and principal should rise each period on a level-payment loan.

Common mistakes in Mortgage Loan Basics and Types

Using the annual rate in a monthly interest calculation.
The question gives an annual rate and the student plugs it in directly.
Fix: Divide by 12 and set n to months before computing interest or payment.
Thinking the principal portion is level on a fixed-rate loan.
The payment is level, so students assume both parts are.
Fix: The payment is level. Interest falls and principal rises each period as the balance drops.
Mixing up recourse and non-recourse.
The words sound similar and students recall only that one is safer.
Fix: Recourse: lender can go beyond the property to other assets. Non-recourse: only the property.
Computing LTV from the down payment instead of the loan.
Students see a down payment percentage and report it as LTV.
Fix: LTV = 1 − down payment as a % of property value. A 25% down payment gives a 75% LTV.
Assuming the borrower bears rate risk on a fixed-rate loan.
Students confuse payment certainty with value certainty.
Fix: Fixed-rate borrowers have payment certainty. The lender faces the opportunity cost if rates rise and prepayment if rates fall. ARM borrowers bear the reset risk.
Treating a balloon loan as fully amortizing.
Students assume the balance always reaches zero.
Fix: Partially amortizing and interest-only loans leave a balance due at maturity.

Worked examples

Example 1

A buyer purchases a home for $380,000. The home is appraised at $400,000. The lender advances $304,000 and, as the question states, measures LTV against the lower of appraised value and purchase price. What is the LTV? A. 20.0% B. 76.0% C. 80.0%

Show the solution

The question says to use the lower of appraised value and purchase price, so the value is $380,000.
LTV = 304,000 ÷ 380,000.
304,000 ÷ 380,000 = 0.80, which is 80.0%.
Using $400,000 would give 76.0%, and 20.0% is the down payment as a share of price (76,000 ÷ 380,000). Both are traps.

Answer: C. 80.0%

Example 2

A borrower takes a $240,000 fully amortizing fixed-rate mortgage at 6% annual interest, paid monthly, with a monthly payment of $1,438.92. What is the principal repaid in the first payment? A. $238.92 B. $1,200.00 C. $1,438.92

Show the solution

Monthly rate = 6% ÷ 12 = 0.5%.
Interest in month 1 = 240,000 × 0.005 = $1,200.00.
Principal = 1,438.92 − 1,200.00 = $238.92.
New balance = 240,000 − 238.92 = $239,761.08, so next month's interest will be slightly lower.

Answer: A. $238.92

Exam tips

Questions often test who bears which risk. Link each feature to borrower or lender before reading the options.
Read carefully for which value the LTV uses: appraised value or purchase price.
For payment calculations on the TI BA II Plus, set P/Y = 12 (C/Y should also be 12; it follows P/Y by default). Then enter N = months, I/Y = annual rate, PV = loan, FV = 0, and press CPT PMT. When PV is positive, the PMT result is negative because it is a cash outflow; ignore the sign.
With three options and no penalty for wrong answers, always answer. Eliminate any option with the wrong direction, such as interest rising over time on a level-payment loan.
Remember that prepayment risk rises when mortgage rates fall below the loan rate.

Practice questions from Mortgage-Backed Security (MBS) Instrument and Market Features

Mortgage Loan Basics and Types in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsReverse Mortgage and Other Retirement Income Sources

Mortgage Loan Basics and Types: frequently asked questions

What is the difference between a fixed-rate and an adjustable-rate mortgage?

A fixed-rate mortgage keeps the same rate for the full term. An adjustable-rate mortgage resets its rate periodically, based on a reference rate plus a margin, often within caps. The borrower bears rate risk on an ARM.

What is the difference between recourse and non-recourse mortgage loans?

With a recourse loan, the lender can pursue the borrower's other assets if the property sale does not cover the debt. With a non-recourse loan, the lender can claim only the property. Non-recourse loans put more credit risk on the lender.

How does a mortgage amortization schedule work?

Each period, interest is the beginning balance times the periodic rate. The rest of the payment reduces principal. Because the balance falls, interest shrinks and principal grows over time on a level-payment loan.

What does a lower LTV mean for credit risk?

A lower LTV means the borrower has more equity in the property. The lender is more likely to recover the loan from a sale if the borrower defaults, so credit risk is lower.