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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

A borrower has a $200,000 fixed-rate mortgage at 6% annual interest, paid monthly, with a payment of $1,199.10. After the first payment, the balance is $199,800.90. In a different scenario, the loan is converted to a negative-amortization option ARM where the borrower pays only $800 in month one at the same rate. What is the loan balance after month one in this option ARM scenario?

The balance rises to $200,200. Interest due is $1,000 for the month, the borrower pays only $800, and the $200 shortfall is capitalized into the principal. This is negative amortization, where the loan balance grows instead of falling.

  1. A$200,200Correct
  2. B$199,800
  3. C$200,000
  4. D$199,000

Explanation

Month-one interest = 200,000 x 0.005 = $1,000. The payment of $800 is $200 short of interest, so the unpaid $200 is added to principal: 200,000 + 200 = $200,200. $199,800 wrongly treats the payment as reducing principal.

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