Learning Objectives
- 1Distinguish between Qualified Mortgages (QM) and Non-Qualified Mortgages (Non-QM), including prohibited features and ATR requirements.
- 2Compare government loan programs (FHA, VA, USDA) including eligibility, insurance, and down payment requirements.
- 3Explain ARM mechanics including index, margin, caps, fully indexed rate, and payment shock risk.
- 4Calculate LTV, CLTV, and DTI ratios and understand their impact on loan qualification and mortgage insurance.
- 5Differentiate between APR and note rate, discount points and lender credits, and primary vs. secondary markets.
- 6Identify nontraditional mortgage risks including payment shock, negative amortization, and balloon payment dangers.
Study Topics
Qualified Mortgages (QM)
Definition: A category of loans that meet strict federal standards under Dodd-Frank designed to ensure the borrower has the Ability to Repay (ATR). QMs protect lenders with a legal safe harbor or rebuttable presumption against borrower lawsuits.
Why SAFE Tests This: QM is the cornerstone of post-2008 mortgage reform. MLOs must know what features are prohibited and what makes a loan qualify as a QM.
Key Rules
| QM Requirement | Detail |
|---|---|
| Max Term | 30 years (no longer) |
| Points & Fees | Cannot exceed 3% of loan amount |
| No Negative Amortization | Balance must never grow |
| No Interest-Only | Must amortize from day one |
| No Balloon Payments | Except small creditor exemption |
| Income/Asset Verification | Must verify ability to repay |
Safe Harbor vs. Rebuttable Presumption
Safe Harbor: If the loan meets QM standards AND the APR does not exceed APOR + 1.5%, the lender has near-absolute legal protection from ATR lawsuits.
Rebuttable Presumption: If the loan is QM but the APR exceeds APOR + 1.5%, the borrower can challenge the lender by proving they lacked ability to repay.
Exam Trap: Assuming all conventional loans are automatically QMs. They must still meet the points/fees and term limits.
Common Wrong Answer: "A QM can have a 40-year term if the borrower has an 800 credit score." (Wrong: Hard limit of 30 years regardless of credit).
Memory Anchor
QM = Safe, Stable, Verified. No toxic features allowed. 30 years max, 3% max fees. Verify everything.
Mnemonic — NIBT (No Icky Bad Terms): No Negative Amortization, Interest-Only Not Allowed, Balloon Payments Banned, Thirty Year Max Term.
Scenario
Key Issue: Interest-only feature is prohibited under QM.
Best Loan/Product: Non-QM Interest-Only loan.
SAFE Trap: Trying to fit this into a QM box because the total term is 30 years.
Explanation: Interest-only payments are strictly prohibited under the QM definition, regardless of total loan term.
RSVP Rapid Review
Qualified Mortgage Max 30 years Max 3% points/fees No interest-only No negative am No balloon Verify income & assets
Quiz Seeds
Common Distractor: QMs require a 20% down payment. (Wrong: Down payment size is not a QM requirement.)
Testing Pattern: "All of the following are prohibited in a QM EXCEPT..."
Common Wrong Assumption: That QM status depends on the borrower’s credit score.
AI Tutor Notes
Tutor Guidance: QM is a federal standard about loan features and verification. Conventional vs. government is about who insures/guarantees the loan. A loan can be both conventional AND a QM.
Related Concepts:
- Ability to Repay (ATR) Rule
- Safe Harbor vs. Rebuttable Presumption
- Non-QM Loans
- Dodd-Frank Act
Ability to Repay (ATR) Rule
Definition: A federal requirement under Dodd-Frank that lenders must make a reasonable, good-faith determination that a borrower can repay the loan before originating it.
Why SAFE Tests This: ATR is the legal foundation for QM. Lenders who violate ATR face borrower lawsuits and regulatory penalties.
Eight ATR Factors
- Current or reasonably expected income or assets
- Current employment status
- Monthly payment on the covered transaction
- Monthly payment on simultaneous loans
- Monthly payment for mortgage-related obligations (taxes, insurance)
- Current debt obligations, alimony, child support
- Monthly DTI ratio or residual income
- Credit history
Exam Trap: Believing ATR only applies to subprime loans. ATR applies to ALL residential mortgage loans (with limited exceptions like HELOCs and reverse mortgages).
Common Wrong Answer: "ATR is satisfied by getting the borrower’s verbal confirmation they can afford the payment."
Memory Anchor
ATR = Can they ACTUALLY pay? Not "do they say they can pay." Verify. Document. Prove it.
RSVP Rapid Review
ATR Rule 8 factors Verify income Verify employment Calculate DTI Document everything No stated-income for QM
Quiz Seeds
Common Distractor: The borrower’s race or national origin. (Wrong: These are prohibited factors under ECOA, not ATR factors.)
Testing Pattern: "Which of the following is NOT one of the eight ATR factors?"
Non-Qualified Mortgages (Non-QM)
Definition: Any residential mortgage that does not meet the QM standards. Non-QM loans are legal but carry higher risk and do not provide lenders with safe harbor protection from ATR lawsuits.
Why SAFE Tests This: MLOs must understand that Non-QM is not illegal—it simply means the lender bears more legal risk and must still comply with ATR.
Key Characteristics
| Feature | Non-QM Example |
|---|---|
| Interest-only payments | Allowed (prohibited in QM) |
| Negative amortization | Allowed (prohibited in QM) |
| Term > 30 years | 40-year terms possible |
| Bank statement loans | Self-employed borrowers |
| Asset depletion | Retirees with large portfolios |
Exam Trap: Assuming Non-QM loans are illegal or predatory. They are legal and serve legitimate borrowers who don’t fit the QM box.
Common Wrong Answer: "Non-QM loans do not require any ability-to-repay analysis." (Wrong: ATR still applies.)
Memory Anchor
Non-QM = Legal but risky. ATR still applies. No safe harbor for lender. Serves self-employed, investors, unique borrowers.
Scenario
Key Issue: Cannot meet QM verification standards with traditional docs.
Best Loan/Product: Non-QM bank statement loan (12-24 months of bank statements).
SAFE Trap: Assuming this borrower cannot get a mortgage at all.
Explanation: Non-QM products exist specifically for borrowers with non-traditional income documentation.
RSVP Rapid Review
Non-QM Legal, not illegal Higher lender risk No safe harbor ATR still required Serves unique borrowers
Conventional / Conforming Loans
Definition: Loans that meet Fannie Mae or Freddie Mac guidelines, including loan limits set annually by FHFA. They are not insured by the government but can be sold on the secondary market.
Why SAFE Tests This: Conforming loans are the most common mortgage product. Understanding their limits and the secondary market is essential.
Key Facts
| Feature | Detail |
|---|---|
| Loan Limits | Set annually by FHFA (varies by county) |
| PMI Required | If LTV > 80% |
| PMI Cancellation | Automatic at 78% LTV; borrower can request at 80% |
| Sold To | Fannie Mae or Freddie Mac (secondary market) |
| Underwriting | DU (Fannie) or LP (Freddie) automated systems |
Exam Trap: Confusing "conventional" with "conforming." All conforming loans are conventional, but not all conventional loans are conforming (jumbo loans are conventional but nonconforming).
Common Wrong Answer: "Fannie Mae insures conventional loans." (Wrong: Fannie Mae guarantees/purchases them; PMI insures them.)
Memory Anchor
Conforming = Fits the box. Fannie & Freddie buy them. PMI if LTV > 80%. Drops at 78% automatically.
RSVP Rapid Review
Conforming Loan Meets Fannie/Freddie guidelines Within loan limits PMI > 80% LTV Sold on secondary market
Quiz Seeds
Common Distractor: PMI automatically drops at 80% LTV. (Wrong: Automatic cancellation is at 78%; borrower can REQUEST at 80%.)
Testing Pattern: Scenarios involving LTV thresholds and PMI rules.
Conventional / Nonconforming (Jumbo)
Definition: Conventional loans that exceed the conforming loan limits set by FHFA, or otherwise do not meet Fannie Mae/Freddie Mac guidelines. Also called "jumbo" loans.
Why SAFE Tests This: Jumbo loans carry higher risk, stricter underwriting, and cannot be sold to Fannie/Freddie. MLOs must understand the differences.
Key Differences from Conforming
| Feature | Conforming | Jumbo |
|---|---|---|
| Loan Amount | Within FHFA limits | Exceeds FHFA limits |
| Secondary Market | Sold to Fannie/Freddie | Held in portfolio or private investors |
| Interest Rates | Generally lower | Generally higher |
| Down Payment | As low as 3% | Typically 10-20%+ |
| Credit Score | 620+ typical | 700+ typical |
Exam Trap: Believing jumbo loans are "government loans" because they are large. They are conventional and not government-backed.
Memory Anchor
Jumbo = Too big for Fannie/Freddie. Higher rate, higher down, higher credit. Held in portfolio.
RSVP Rapid Review
Jumbo Loan Exceeds conforming limits Not sold to GSEs Higher rates Stricter underwriting
Subprime Mortgages
Definition: Loans made to borrowers with poor credit histories (typically below 620 FICO) at higher interest rates to compensate for increased default risk.
Why SAFE Tests This: Subprime lending was central to the 2008 financial crisis. SAFE tests understanding of the risks and regulatory response (Dodd-Frank/QM rules).
Key Characteristics
- Higher interest rates than prime loans
- Borrowers with credit scores typically below 620
- Higher default rates
- Often featured toxic terms pre-2008 (now restricted by QM rules)
- Higher points and fees
Historical Context: Pre-2008 subprime loans often had no income verification ("stated income"), teaser rates, and negative amortization. These features are now prohibited in QM loans.
Exam Trap: Assuming subprime loans are illegal. They are legal but heavily regulated post-Dodd-Frank.
Common Wrong Answer: "Subprime loans no longer exist." (Wrong: They exist but must comply with ATR rules.)
Memory Anchor
Subprime = Below prime credit. Higher rate, higher risk. Legal but regulated. Caused the 2008 crisis.
RSVP Rapid Review
Subprime Below 620 FICO Higher rates Higher default risk Still legal, still regulated ATR still applies
FHA Loans
Definition: Mortgages insured by the Federal Housing Administration (part of HUD), designed to help low-to-moderate-income borrowers purchase homes with lower down payments and more flexible credit requirements.
Why SAFE Tests This: FHA is one of the most commonly used loan programs. SAFE heavily tests its specific insurance premiums, occupancy rules, and down payment requirements.
Key Facts
| Feature | FHA Requirement |
|---|---|
| Min Down Payment | 3.5% (credit score 580+) |
| Min Down (low score) | 10% (credit score 500-579) |
| Occupancy | Primary residence ONLY |
| UFMIP | 1.75% of loan amount (financed into loan) |
| Annual MIP | Lasts life of loan if < 10% down; ends after 11 years if ≥ 10% down |
| Assumable | Yes (with lender approval) |
| Loan Limits | Set by county (lower than conforming in most areas) |
Critical Distinction: FHA uses MIP (Mortgage Insurance Premium), NOT PMI (Private Mortgage Insurance). MIP has both an upfront component AND an annual component. PMI is only on conventional loans.
Exam Trap: Confusing FHA MIP with conventional PMI. FHA MIP lasts the life of the loan if the down payment is < 10% (ends after 11 years if ≥ 10% down). Conventional PMI drops at 78% LTV.
Common Wrong Answer: "FHA loans require zero down payment." (Wrong: Only VA and USDA offer zero down.)
Memory Anchor
FHA = 3.5% down, Primary Only, MIP. UFMIP = 1.75% upfront (financed). MIP stays for life if < 10% down. NOT PMI. Never investment property.
Scenario
Key Issue: FHA is primary residence only.
SAFE Trap: Approving FHA because the score and down payment fit the requirements.
Correct Action: Deny FHA for investment property. Explore conventional options with higher down payment.
Explanation: FHA loans are strictly for primary residences, regardless of how well the borrower otherwise qualifies.
RSVP Rapid Review
FHA Loan 3.5% minimum down (580+ score) 10% down (500-579 score) Primary residence ONLY MIP (not PMI) 1.75% UFMIP upfront Assumable with approval
Quiz Seeds
Common Distractor: FHA MIP drops off at 80% LTV like conventional PMI.
Testing Pattern: "Which of the following is TRUE about FHA loans?"
AI Tutor Notes
Tutor Guidance: PMI = Private (conventional only, drops at 78%). MIP = Mortgage Insurance Premium (FHA only, has upfront + annual, often permanent). Different programs, different rules.
Related Concepts:
- UFMIP (Upfront Mortgage Insurance Premium)
- PMI vs. MIP
- VA Funding Fee
- USDA Guarantee Fee
VA Loans
Definition: Mortgages guaranteed by the Department of Veterans Affairs for eligible veterans, active-duty service members, and surviving spouses. Offers zero down payment and no monthly mortgage insurance.
Why SAFE Tests This: VA loans have unique features (no PMI, no down payment, residual income test) that distinguish them from all other programs.
Key Facts
| Feature | VA Requirement |
|---|---|
| Down Payment | $0 (100% financing) |
| Monthly MI | NONE (no PMI or MIP) |
| Funding Fee | One-time fee (varies 1.25%-3.3%); can be financed |
| Occupancy | Primary residence only |
| Eligibility | Veterans, active duty, National Guard, surviving spouses |
| Income Test | Residual income (not just DTI) |
| Assumable | Yes (with VA approval) |
| Prepayment Penalty | NONE |
Exam Trap: Believing VA loans have no costs at all. They have a Funding Fee (which can be waived for disabled veterans).
Common Wrong Answer: "VA loans require PMI because there is no down payment." (Wrong: VA has NO monthly mortgage insurance.)
Memory Anchor
VA = Veterans, Zero Down, No PMI. Funding Fee instead (waived if disabled). Residual Income test (unique to VA). Primary residence only.
Scenario
Key Issue: VA is primary residence only.
SAFE Trap: Approving because the veteran is eligible.
Correct Action: Deny VA for vacation/second home. VA requires the borrower to certify intent to occupy as primary residence.
Explanation: VA eligibility alone is not enough; the property must be the borrower’s primary residence.
RSVP Rapid Review
VA Loan Zero down payment No PMI ever Funding fee (waived if disabled) Residual income test Primary residence only Assumable
Quiz Seeds
Common Distractor: VA loans use DTI as the sole qualifying metric.
Clarification: VA uniquely uses residual income IN ADDITION to DTI.
USDA Loans
Definition: Mortgages guaranteed by the U.S. Department of Agriculture for eligible borrowers purchasing homes in designated rural areas. Offers zero down payment with income limits.
Why SAFE Tests This: USDA has unique geographic and income eligibility restrictions that distinguish it from FHA and VA.
Key Facts
| Feature | USDA Requirement |
|---|---|
| Down Payment | $0 (100% financing) |
| Geographic | Rural areas only (USDA-designated) |
| Income Limit | Cannot exceed 115% of area median income |
| Occupancy | Primary residence only |
| Guarantee Fee | Upfront (1%) + Annual (0.35%) |
| Credit | No federal minimum; lenders typically require 640+ (overlay) |
Exam Trap: Assuming USDA is only for farms. USDA "rural" includes many suburban areas outside major metro zones.
Common Wrong Answer: "USDA has no income limits." (Wrong: Household income cannot exceed 115% of area median.)
Memory Anchor
USDA = Rural, Zero Down, Income Limits. Not just farms! 115% AMI max income. Guarantee fee (not MIP, not PMI).
RSVP Rapid Review
USDA Loan Zero down payment Rural areas only Income limits (115% AMI) Guarantee fee Primary residence only
Quiz Seeds
Common Distractor: USDA loans are available in any location if the borrower has low income.
Clarification: BOTH geographic eligibility AND income limits must be met.
Government Loan Comparison Table
Side-by-Side Comparison
| Feature | FHA | VA | USDA |
|---|---|---|---|
| Down Payment | 3.5% | 0% | 0% |
| Monthly Insurance | MIP (annual) | NONE | Guarantee fee (annual) |
| Upfront Fee | 1.75% UFMIP | Funding Fee (varies) | 1% Guarantee Fee |
| Occupancy | Primary only | Primary only | Primary only |
| Eligibility | All borrowers | Veterans/military | Rural + income limits |
| Credit Score | 500+ (with 10% down) | No VA minimum (lender overlays) | No federal min; 640+ overlay |
| Assumable | Yes | Yes | Yes |
Memory Trick: All three government loans are assumable and require primary residence occupancy. The key differences are: WHO qualifies (everyone vs. veterans vs. rural/income-limited) and WHAT insurance looks like.
RSVP Rapid Review
Government Loans All primary residence only All assumable FHA = 3.5% down + MIP VA = 0% down + No MI + Funding Fee USDA = 0% down + Rural + Income Limits
Fixed-Rate Mortgages
Definition: A mortgage with an interest rate that remains constant for the entire life of the loan. The monthly principal and interest payment never changes.
Why SAFE Tests This: Fixed-rate is the benchmark product. SAFE tests the ability to compare it against ARMs and explain suitability to borrowers.
Key Characteristics
- Rate locked for entire term (15, 20, 25, or 30 years)
- Predictable P&I payment (taxes and insurance may still change)
- No payment shock risk
- Higher initial rate than ARM (borrower pays for stability)
- Best for borrowers planning to stay long-term
Exam Trap: Believing the total monthly payment never changes. Only P&I is fixed; escrow (taxes/insurance) can still fluctuate.
Common Wrong Answer: "A fixed-rate mortgage guarantees the same total payment every month."
Memory Anchor
Fixed Rate = Stability. Rate never moves. P&I never moves. Escrow CAN move (taxes/insurance).
RSVP Rapid Review
Fixed-Rate Mortgage Same rate forever Same P&I payment No payment shock Higher initial rate than ARM Best for long-term owners
Quiz Seeds
Common Distractor: The total monthly payment is guaranteed to never change.
Clarification: Only P&I is fixed. Escrow adjustments can change the total payment.
Adjustable-Rate Mortgages (ARMs)
Definition: A mortgage where the interest rate adjusts periodically based on a financial index plus a fixed margin. The rate (and payment) can increase or decrease over time.
Why SAFE Tests This: ARM mechanics (index, margin, caps, fully indexed rate) are heavily tested. MLOs must calculate rates and explain payment shock risk.
ARM Components
| Component | Description | Key Fact |
|---|---|---|
| Index | Public financial benchmark (e.g., SOFR, 1-yr Treasury) | Changes with the market |
| Margin | Lender’s fixed profit added to index | NEVER changes |
| Fully Indexed Rate | Index + Margin = Current Rate | Used for qualification |
| Initial Cap | Max rate increase at first adjustment | Often 2% or 5% |
| Periodic Cap | Max rate change per adjustment period | Often 2% |
| Lifetime Cap | Max rate increase over life of loan | Often 5% or 6% |
ARM Naming Convention
A 5/1 ARM means: Fixed for 5 years, then adjusts every 1 year. A 7/6 ARM means: Fixed for 7 years, then adjusts every 6 months.
Critical Formula: Fully Indexed Rate = Index + Margin. Example: If Index = 3.5% and Margin = 2.5%, then Fully Indexed Rate = 6.0%.
Exam Trap: Confusing the Index (which fluctuates) with the Margin (which is FIXED). The margin NEVER changes.
Common Wrong Answer: "The margin changes every year based on the market." (Wrong: Only the index changes.)
Memory Anchor
Index = Moves (market-driven). Margin = Mine (lender’s fixed profit). Rate = Index + Margin. Caps = Safety limits.
Scenario
Key Issue: Does the rate jump to 8%?
SAFE Trap: Ignoring the cap structure.
Correct Action: The initial cap is 2%, so the max rate at first adjustment is 4% + 2% = 6%, NOT 8%.
Explanation: Caps protect the borrower from unlimited rate increases, even if the fully indexed rate is higher.
RSVP Rapid Review
ARM Index + Margin = Rate Index moves, Margin stays Caps: Initial / Periodic / Lifetime Payment shock risk Lower initial rate than fixed
Quiz Seeds
Common Distractor: The margin is determined by the Federal Reserve.
Clarification: The margin is set by the lender at origination and never changes. The index is a public market rate.
AI Tutor Notes
Tutor Guidance: Think of it like a restaurant bill: the Index is the food price (changes daily), the Margin is the tip percentage (always the same). Your total bill = food + tip. Rate = Index + Margin.
Related Concepts:
- SOFR (Secured Overnight Financing Rate)
- Payment Shock
- Nontraditional Mortgage Risk
- Fully Indexed Rate Calculation
Reverse Mortgages (HECM)
Definition: A Home Equity Conversion Mortgage (HECM) insured by FHA that allows homeowners age 62+ to convert home equity into cash without making monthly mortgage payments. The loan becomes due when the borrower dies, sells, or permanently moves out.
Why SAFE Tests This: Reverse mortgages have unique rules (age requirement, counseling, repayment triggers) that are frequently tested.
Key Facts
| Feature | HECM Requirement |
|---|---|
| Minimum Age | 62 years old |
| Counseling | HUD-approved counseling REQUIRED before application |
| Monthly Payments | NONE required from borrower |
| Repayment Triggers | Death, sale, move out, failure to pay taxes/insurance |
| Non-Recourse | Borrower/heirs never owe more than home value |
| Occupancy | Primary residence only |
Exam Trap: Believing the bank "takes the house" with a reverse mortgage. The borrower retains title and ownership.
Common Wrong Answer: "The lender owns the home during a reverse mortgage." (Wrong: Borrower retains title.)
Memory Anchor
Reverse = 62+, No payments, Counseling required. Loan due at death/sale/move. Borrower keeps title. Non-recourse (never owe more than home value).
RSVP Rapid Review
Reverse Mortgage (HECM) Age 62+ No monthly payments Counseling required Due at death/sale/move Borrower keeps title Non-recourse
Quiz Seeds
Common Distractor: The borrower must make monthly interest payments.
Clarification: No monthly mortgage payments are required; interest accrues and is added to the balance.
Home Equity Line of Credit (HELOC)
Definition: A revolving line of credit secured by the borrower’s home equity. Works like a credit card: borrow, repay, and re-borrow during the draw period.
Why SAFE Tests This: HELOCs are open-end credit (not covered by TRID) with unique draw/repayment periods. SAFE tests the structural differences from closed-end loans.
Key Characteristics
| Feature | HELOC |
|---|---|
| Credit Type | Open-end (revolving) |
| Draw Period | Typically 5-10 years (borrow as needed) |
| Repayment Period | Typically 10-20 years (no more draws) |
| Rate | Usually variable/adjustable |
| Payment During Draw | Often interest-only |
| TRID Applies? | NO (open-end credit is exempt) |
Exam Trap: Confusing HELOC (revolving, variable rate) with Home Equity Loan (closed-end, fixed rate, lump sum).
Common Wrong Answer: "A HELOC provides a lump sum at closing." (Wrong: That is a home equity loan.)
Memory Anchor
HELOC = Home Equity Credit Card. Draw period (borrow), then Repayment period (pay back). Variable rate. Open-end. NOT covered by TRID.
RSVP Rapid Review
HELOC Revolving credit Variable rate Draw period + Repayment period Open-end (no TRID) Like a credit card on your house
Quiz Seeds
Common Distractor: A Loan Estimate must be provided for a HELOC within 3 business days.
Clarification: TRID does not apply to open-end credit. HELOCs are disclosed under TILA open-end rules instead.
Balloon Mortgages
Definition: A mortgage with regular monthly payments for a set period (often 5-7 years), followed by one large "balloon" payment of the remaining balance due at maturity.
Why SAFE Tests This: Balloon payments are prohibited in QM loans (with limited exceptions). They carry significant refinancing risk.
Key Risks
- Borrower must refinance or sell before balloon payment is due
- If rates rise or credit deteriorates, refinancing may be impossible
- Prohibited in Qualified Mortgages (except small creditor exemption)
- Payment shock at maturity
Exam Trap: Believing balloon mortgages are completely illegal. They are prohibited in QM but still legal as Non-QM products.
Common Wrong Answer: "Balloon mortgages were banned by Dodd-Frank." (Wrong: Banned from QM only.)
Memory Anchor
Balloon = Big payment at the end. Must refinance or sell. Banned from QM. Legal as Non-QM.
RSVP Rapid Review
Balloon Mortgage Regular payments then BIG final payment Refinance risk Prohibited in QM Legal as Non-QM Payment shock at maturity
Interest-Only Mortgages
Definition: A mortgage where the borrower pays only interest (no principal) for an initial period (typically 5-10 years), after which the loan converts to fully amortizing payments.
Why SAFE Tests This: Interest-only is a prohibited QM feature and carries significant payment shock risk when the amortization period begins.
Key Risks
- No equity built during interest-only period
- Significant payment increase when amortization begins
- Prohibited in Qualified Mortgages
- Borrower may owe more than the home is worth if values decline
Payment Shock Example: A $300,000 loan at 6% interest-only = $1,500/month. When it converts to fully amortizing over 20 years, payment jumps to ~$2,149/month (43% increase).
Exam Trap: Believing interest-only loans build equity. They do NOT—the balance stays the same during the IO period.
Memory Anchor
Interest-Only = No equity building. Payment shock when IO period ends. Banned from QM. Balance stays flat.
RSVP Rapid Review
Interest-Only Mortgage Pay interest, no principal No equity built Payment shock later Prohibited in QM Legal as Non-QM
Construction Mortgages
Definition: Short-term financing used to fund the building of a new home. Funds are disbursed in "draws" as construction milestones are completed, then typically converted to permanent financing.
Why SAFE Tests This: Construction loans have unique disbursement mechanics (draws, inspections) that differ from standard purchase loans.
Key Features
- Short-term (6-18 months typically)
- Interest-only payments during construction (on amount drawn)
- Funds released in draws after inspections
- Construction-to-permanent: converts to regular mortgage after completion
- Two-close: separate construction loan then permanent loan
Memory Anchor
Construction = Build first, permanent later. Draws released after inspections. Interest on amount drawn only. Short-term then converts.
RSVP Rapid Review
Construction Loan Short-term financing Draws after inspections Interest on drawn amount Converts to permanent One-close or two-close
Annual Percentage Rate (APR)
Definition: The total cost of credit expressed as a yearly rate. Includes the interest rate PLUS certain fees and financing costs (origination fees, discount points, mortgage insurance premiums).
Why SAFE Tests This: APR is the primary tool for consumers to compare the true cost of loans under TILA. Required in all advertising that mentions a rate.
APR vs. Note Rate
| Note Rate | APR |
|---|---|
| Used to calculate monthly P&I payment | Used to compare total loan cost |
| Does NOT include fees | INCLUDES certain fees |
| Always lower than APR | Always higher than note rate |
| On the promissory note | On disclosures (LE, CD) |
Exam Trap: Believing the APR is the rate used to calculate the monthly payment. It is NOT—the note rate calculates the payment.
Common Wrong Answer: "APR equals the interest rate." (Wrong: APR includes financing costs and is always higher.)
Memory Anchor
Note Rate = Payment calculator. APR = True cost comparator. APR always > Note Rate. Required in advertising (TILA).
RSVP Rapid Review
APR Total cost of credit Includes fees + interest Always higher than note rate Required in ads (TILA) Comparison tool for borrowers
Quiz Seeds
Common Distractor: Appraisal fees are included in the APR.
Clarification: Third-party fees not retained by the lender (appraisal, credit report) are generally NOT in APR. Origination fees and discount points ARE included.
Discount Points
Definition: Prepaid interest paid at closing to reduce ("buy down") the interest rate. One point = 1% of the loan amount.
Why SAFE Tests This: Points affect APR, borrower costs, and the break-even calculation. SAFE tests whether students understand the trade-off.
Key Facts
- 1 point = 1% of loan amount (e.g., 1 point on $200,000 = $2,000)
- Typically reduces rate by ~0.25% per point (varies by lender)
- Increases upfront cost but decreases monthly payment
- Included in APR calculation
- Tax deductible in the year paid (for purchase loans)
Exam Trap: Confusing discount points (borrower pays to lower rate) with origination points (lender charges for processing the loan).
Common Wrong Answer: "Discount points always save the borrower money." (Wrong: Only if the borrower keeps the loan long enough to reach the break-even point.)
Memory Anchor
Points = Prepaid interest. 1 point = 1% of loan. Pay more now, pay less monthly. Break-even: How long to recoup?
RSVP Rapid Review
Discount Points 1 point = 1% of loan amount Prepaid interest Lowers the rate Increases APR Break-even analysis needed
Escrow Accounts
Definition: An account held by the lender/servicer to collect and pay property taxes and homeowner’s insurance on behalf of the borrower. Funded monthly as part of the mortgage payment (the "TI" in PITI).
Why SAFE Tests This: Escrow rules (RESPA Section 10) limit how much lenders can collect and require annual analysis and refunds.
Key Rules
- Lender can hold a maximum 2-month cushion
- Annual escrow analysis required
- Surplus > $50 must be refunded within 30 days
- Shortage can be spread over 12 months
- Required for most FHA and VA loans
Exam Trap: Believing the lender can hold unlimited escrow funds. RESPA limits the cushion to 2 months of anticipated disbursements.
Memory Anchor
Escrow = Taxes + Insurance savings account. Max 2-month cushion (RESPA). Annual analysis required. Surplus > $50 = Refund in 30 days.
RSVP Rapid Review
Escrow Account Taxes + Insurance 2-month max cushion Annual analysis Refund surplus > $50 Part of PITI payment
Table Funding
Definition: A settlement at which a loan is funded by a lender other than the one that originated the loan. The originating lender closes the loan in its own name, then immediately assigns it to the funding lender at the closing table.
Why SAFE Tests This: Table funding is common in wholesale lending. SAFE tests whether students understand the distinction from a secondary market sale.
Key Facts
- Loan is originated by one entity but funded by another at closing
- NOT a secondary market transaction (happens simultaneously at closing)
- The originator is still considered the "creditor" for disclosure purposes
- Common in mortgage broker/wholesale lender relationships
Exam Trap: Confusing table funding with selling a loan on the secondary market. Table funding happens AT closing; secondary market sales happen AFTER closing.
Memory Anchor
Table Funding = Funded by someone else AT the table. Not secondary market (that’s after closing). Wholesale lending model. Originator still = creditor for disclosures.
RSVP Rapid Review
Table Funding Funded at closing by another lender Not secondary market Happens simultaneously Wholesale lending Originator = creditor for disclosures
Subordination & Lien Priority
Definition: The process of changing the priority order of liens on a property. A subordination agreement allows a new first mortgage to take priority over an existing second mortgage or HELOC.
Why SAFE Tests This: Lien priority determines who gets paid first in foreclosure. Subordination is critical when refinancing with existing second liens.
Key Concepts
- First lien = highest priority (paid first in foreclosure)
- Second lien = subordinate (paid after first lien)
- Refinancing a first mortgage requires the second lienholder to agree to subordinate
- Without subordination, the new loan becomes a second lien
Exam Trap: Assuming a refinance automatically maintains first lien position. The existing second lienholder must agree to subordinate.
Memory Anchor
Subordination = "I agree to stay behind." First lien = First paid. Refinance needs subordination agreement. Priority matters in foreclosure.
RSVP Rapid Review
Subordination Lien priority order First lien paid first Refinance needs agreement Second lienholder must consent Critical in foreclosure
2-1 Buydown
Definition: A temporary buydown where the interest rate is reduced by 2% in year one, 1% in year two, then returns to the full note rate in year three and beyond. Often paid by the seller or builder as a concession.
Why SAFE Tests This: Buydowns are common seller concessions. SAFE tests whether students understand the temporary nature and qualification requirements.
Example (Note Rate = 6%)
| Year | Effective Rate | Reduction |
|---|---|---|
| Year 1 | 4% | -2% |
| Year 2 | 5% | -1% |
| Year 3+ | 6% | Full note rate |
Exam Trap: Believing the borrower qualifies at the reduced rate. Most programs require qualification at the full note rate (6% in this example).
Common Wrong Answer: "A 2-1 buydown permanently reduces the interest rate." (Wrong: It is temporary.)
Memory Anchor
2-1 Buydown = Temporary rate reduction. Year 1: -2%, Year 2: -1%, Year 3: Full rate. Qualify at full note rate. Often seller-paid.
RSVP Rapid Review
2-1 Buydown Temporary (not permanent) Year 1: -2%, Year 2: -1% Year 3+: Full note rate Qualify at full rate Seller/builder concession
Loan-to-Value (LTV) Ratio
Definition: The ratio of the first mortgage loan amount to the lesser of the property’s appraised value or purchase price. Expressed as a percentage.
Formula: LTV = Loan Amount ÷ Lesser of (Appraised Value OR Purchase Price) × 100
Why SAFE Tests This: LTV drives PMI requirements, interest rates, and loan program eligibility. It is one of the most frequently calculated ratios on the exam.
Key Thresholds
| LTV | Significance |
|---|---|
| > 80% | PMI required (conventional) |
| 80% | Borrower can REQUEST PMI cancellation |
| 78% | PMI AUTOMATICALLY cancelled |
| 97% | Max conventional LTV (3% down) |
| 96.5% | Max FHA LTV (3.5% down) |
| 100% | VA and USDA (zero down) |
Exam Trap: Using the HIGHER of purchase price or appraised value. Always use the LESSER (more conservative).
Common Wrong Answer: "LTV is calculated using the appraised value because it represents true market value."
Calculation Example
Loan Amount: $200,000 - $20,000 = $180,000
Value Used: Lesser of $200,000 or $210,000 = $200,000
LTV: $180,000 ÷ $200,000 = 90%
Result: PMI required (LTV > 80%)
Memory Anchor
LTV = Loan ÷ Lesser Value. Use the LOWER number. > 80% = PMI. 78% = Auto-cancel. 80% = Request cancel.
RSVP Rapid Review
LTV Ratio Loan ÷ Lesser of Value or Price > 80% = PMI required 80% = Request cancellation 78% = Automatic cancellation Always use lesser value
Quiz Seeds
Common Distractor: Using the higher value to calculate a lower LTV.
Testing Pattern: "A borrower purchases a home for $250,000. The appraisal comes in at $260,000. With a $25,000 down payment, what is the LTV?"
Combined Loan-to-Value (CLTV)
Definition: The ratio of ALL mortgage liens on a property (first mortgage + second mortgage + HELOC) divided by the property value.
Formula: CLTV = (First Mortgage + Second Mortgage + HELOC balance) ÷ Property Value × 100
Key Difference from LTV
| LTV | CLTV |
|---|---|
| First mortgage only | ALL liens combined |
| Used for PMI decisions | Used for total risk assessment |
| Always ≤ CLTV | Always ≥ LTV |
Calculation Example
LTV: $200,000 ÷ $300,000 = 66.7%
CLTV: ($200,000 + $30,000) ÷ $300,000 = 76.7%
Exam Trap: Forgetting to include the HELOC or second mortgage in the CLTV calculation.
Memory Anchor
CLTV = ALL liens combined. LTV = First mortgage only. CLTV is always ≥ LTV. Include HELOCs and seconds!
RSVP Rapid Review
CLTV All liens combined First + Second + HELOC Divided by property value Always ≥ LTV Total risk picture
Debt-to-Income (DTI) Ratio
Definition: The percentage of a borrower’s gross monthly income that goes toward paying debts. There are two types: Front-End (housing only) and Back-End (all debts).
Formulas:
Front-End DTI = PITI ÷ Gross Monthly Income × 100
Back-End DTI = (PITI + All Monthly Debts) ÷ Gross Monthly Income × 100
Common DTI Guidelines
| Loan Type | Front-End Max | Back-End Max |
|---|---|---|
| Conventional | 28% (guideline) | 36-45% (with AUS approval up to 50%) |
| FHA | 31% | 43% (up to 57% with compensating factors) |
| VA | No strict front-end | 41% guideline + residual income |
Exam Trap: Using NET income instead of GROSS income. DTI always uses GROSS (before taxes).
Common Wrong Answer: "DTI is calculated using take-home pay." (Wrong: Always gross monthly income.)
Calculation Example
Front-End DTI: $2,000 ÷ $8,000 = 25%
Back-End DTI: ($2,000 + $400 + $200 + $200) ÷ $8,000 = $2,800 ÷ $8,000 = 35%
Memory Anchor
DTI = Debts ÷ GROSS Income. Front-End = Housing only (PITI). Back-End = ALL debts + PITI. Always GROSS, never net.
Mnemonic — PITI: Principal, Interest, Taxes, Insurance (the four components of a housing payment).
RSVP Rapid Review
DTI Ratio Debts ÷ Gross Income Front-End = PITI only Back-End = ALL debts Use GROSS income (before taxes) Lower DTI = less risk
Quiz Seeds
Common Distractor: Including utilities in the DTI calculation.
Clarification: Utilities are NOT included in DTI. Only recurring debt obligations that appear on a credit report (plus PITI) are included.
PITI (Principal, Interest, Taxes, Insurance)
Definition: The four components that make up a borrower’s total monthly housing payment: Principal (loan balance reduction), Interest (cost of borrowing), Taxes (property taxes), and Insurance (homeowner’s insurance + MI if applicable).
Why SAFE Tests This: PITI is the basis for front-end DTI calculations and escrow account funding.
Components
| Letter | Component | Note |
|---|---|---|
| P | Principal | Reduces loan balance |
| I | Interest | Cost of borrowing (based on note rate) |
| T | Taxes | Property taxes (escrowed monthly) |
| I | Insurance | Homeowner’s + PMI/MIP if applicable |
Exam Trap: Forgetting that PMI/MIP is included in the "Insurance" portion of PITI for DTI calculations.
Memory Anchor
PITI = Total housing payment. Principal + Interest + Taxes + Insurance. Used for front-end DTI. Escrow covers T and I.
RSVP Rapid Review
PITI Principal Interest Taxes Insurance (includes MI) = Total housing payment = Front-end DTI numerator
APR vs. Interest Rate
| Interest Rate (Note Rate) | APR |
|---|---|
| Cost of borrowing money only | Total cost of credit including fees |
| Used to calculate monthly P&I | Used to COMPARE loan offers |
| Does not include closing costs | Includes origination fees, points, MI |
| Lower number | Always higher than note rate |
| On the promissory note | On disclosures and advertisements |
Quick Rule: If someone asks "what’s my payment?" → use note rate. If someone asks "which loan costs less overall?" → compare APRs.
RSVP Rapid Review
Note Rate = Payment APR = True Cost APR always higher APR includes fees Note Rate does not
QM vs. Non-QM
| Qualified Mortgage (QM) | Non-Qualified Mortgage (Non-QM) |
|---|---|
| Meets Dodd-Frank/ATR safe harbor | Does NOT meet QM standards |
| Max 30-year term | Can exceed 30 years |
| No interest-only, no balloon, no neg-am | May include these features |
| Max 3% points and fees | No cap on points/fees |
| Full income/asset verification | Alternative documentation (bank statements) |
| Lender has safe harbor protection | Lender has NO safe harbor |
| Lower risk | Higher risk (but still legal) |
Quick Rule: QM = Safe, Stable, Verified. Non-QM = Flexible but risky for the lender.
RSVP Rapid Review
QM = Safe harbor, strict rules Non-QM = No safe harbor, flexible Both legal Both require ATR QM protects lender from lawsuits
FHA vs. Conventional
| Feature | FHA | Conventional |
|---|---|---|
| Insurance | MIP (upfront + annual, often permanent) | PMI (cancellable at 78-80% LTV) |
| Min Down | 3.5% | 3% (conforming) |
| Credit Score | 500+ (with 10% down) | 620+ typical |
| MI Duration | Life of loan (if < 10% down) | Drops at 78% LTV |
| Loan Limits | FHA county limits (lower) | Conforming limits (higher) |
| Property | Primary only | Primary, second home, investment |
| Assumable | Yes | Generally no |
Quick Rule: FHA = easier to qualify, harder to remove MI. Conventional = harder to qualify, easier to remove PMI.
RSVP Rapid Review
FHA: MIP stays (often life of loan) Conventional: PMI drops at 78% FHA: 3.5% down, 500+ credit Conventional: 3% down, 620+ credit FHA: Primary only Conventional: Any occupancy
HELOC vs. Home Equity Loan
| HELOC | Home Equity Loan |
|---|---|
| Revolving credit (like a credit card) | Closed-end (lump sum) |
| Variable/adjustable rate | Fixed rate |
| Draw period + repayment period | Fixed monthly payments from day one |
| Borrow as needed up to limit | Receive full amount at closing |
| Open-end credit (no TRID) | Closed-end credit (TRID applies) |
| Payment varies with balance/rate | Payment is fixed |
Quick Rule: HELOC = credit card on your house. Home Equity Loan = second mortgage with fixed payments.
RSVP Rapid Review
HELOC = Revolving, Variable, No TRID Home Equity Loan = Lump sum, Fixed, TRID applies Both use home as collateral Both are second liens typically
Conforming vs. Nonconforming
| Conforming | Nonconforming (Jumbo) |
|---|---|
| Within FHFA loan limits | Exceeds FHFA loan limits |
| Meets Fannie/Freddie guidelines | Does NOT meet GSE guidelines |
| Sold on secondary market easily | Held in portfolio or private investors |
| Lower interest rates | Higher interest rates |
| Standard underwriting | Stricter underwriting |
| Lower down payment options | Higher down payment required |
Quick Rule: Conforming = fits the Fannie/Freddie box. Nonconforming = too big or too different.
RSVP Rapid Review
Conforming = Within limits, sold to GSEs Nonconforming = Over limits, portfolio Both are conventional Conforming = lower rates Nonconforming = stricter rules
Primary Market vs. Secondary Market
| Primary Market | Secondary Market |
|---|---|
| Where loans are ORIGINATED | Where loans are BOUGHT and SOLD |
| Borrower interacts here | Borrower does NOT interact here |
| Lenders, brokers, credit unions | Fannie Mae, Freddie Mac, Ginnie Mae |
| Creates new loans | Provides liquidity to create more loans |
| Direct lending relationship | Investor/guarantor relationship |
Quick Rule: Primary = where you GET a loan. Secondary = where lenders SELL loans to get money to make more loans.
Exam Trap: Believing borrowers interact with the secondary market. They do not. The secondary market provides liquidity behind the scenes.
Memory Anchor
Primary = People get loans here. Secondary = Loans get sold here. Fannie/Freddie/Ginnie = Secondary. Banks/Brokers = Primary. Secondary provides liquidity.
RSVP Rapid Review
Primary Market = Origination Secondary Market = Buying/Selling loans Borrower only sees primary Secondary provides liquidity Fannie, Freddie, Ginnie = Secondary
Fixed Rate vs. ARM
| Fixed Rate | ARM |
|---|---|
| Rate never changes | Rate adjusts periodically |
| Higher initial rate | Lower initial rate |
| No payment shock | Payment shock risk |
| Best for long-term owners | Best for short-term owners |
| Predictable budgeting | Uncertainty after fixed period |
| No caps needed | Caps protect from extreme increases |
Quick Rule: Fixed = stability at a premium. ARM = lower start but risk later. Match to borrower’s time horizon.
RSVP Rapid Review
Fixed = Stable, higher initial rate ARM = Lower start, risk later Fixed = long-term owners ARM = short-term or expecting income growth ARM has caps for protection
PMI vs. MIP
| PMI (Private Mortgage Insurance) | MIP (Mortgage Insurance Premium) |
|---|---|
| Conventional loans only | FHA loans only |
| Required when LTV > 80% | Always required regardless of LTV |
| Cancellable at 80% (request) / 78% (auto) | Often lasts life of loan (if < 10% down) |
| No upfront component | Upfront (1.75% UFMIP) + Annual |
| Paid to private insurance company | Paid to FHA/HUD |
| Cost varies by credit score & LTV | Standard rates set by FHA |
Quick Rule: PMI = Private, Cancellable, Conventional. MIP = FHA, Usually Permanent, Has Upfront Component.
RSVP Rapid Review
PMI = Conventional, drops at 78% MIP = FHA, often permanent PMI = no upfront fee MIP = 1.75% upfront + annual PMI = private company MIP = paid to FHA