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

A borrower takes a 25-year mortgage whose monthly payments cover interest only for the first five years. After that, payments rise so that the loan is fully repaid by maturity. This loan is best described as:

It is an interest-only mortgage that later becomes fully amortizing. The borrower pays only interest at first, so the balance stays unchanged, then pays interest plus principal so the loan is fully repaid at maturity with no balloon payment and no growth in the balance.

  1. Aa balloon mortgage with a bullet payment at maturity
  2. Ban interest-only mortgage that later becomes fully amortizingCorrect
  3. Ca negative amortization mortgage with deferred interest

Explanation

Interest-only payments initially leave the principal unchanged. Later payments include principal and fully repay the loan by maturity, so there is no balloon. Negative amortization would require the balance to grow because payments are below interest due, which is not described.

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