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AIM 11: Discuss the difference between predatory lending and borrowing.

1、Which of the following best illustrates predatory borrowing?

A) Jumbo loan with high LTV.

B) Conforming loan with high LTV.

C) Jumbo loan with low LTV.

D) Conforming loan with low LTV.

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The correct answer is A

The riskiest borrower would be one who borrows a large amount with relatively little downpayment. Jumbo loans are above the conforming limit for GSE securitization and high LTV indicates low downpayment.

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2、Which of the following best illustrates predatory lending?

A) Issuing sophisticated borrowers adjustable rate mortgages.

B) Issuing unsophisticated borrowers adjustable rate mortgages.

C) Issuing unsophisticated borrowers fixed rate mortgages.

D) Issuing sophisticated borrowers fixed rate mortgages.

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The correct answer is B

Unsophisticated borrowers are most likely to underestimate the likelihood and magnitude of changes in payments from adjustable rate mortgages.

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3、Predatory borrowing is most likely to occur under which economic environment?

A) Rapid home appreciation in high price real estate markets.

B) Rapid home appreciation in moderate price real estate markets.

C) Moderate home appreciation in high price markets.

D) Moderate home appreciation in moderate price markets.

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The correct answer is A

During rapid real estate markets, the borrowers are worried that the longer they wait to buy a home the higher the price. This is exacerbated in markets with high home prices. Therefore borrowers may overstate or falsify their creditworthiness because the risk of waiting is perceived as significant.

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4、Helen and Harrison Woodfield are considering have agreed to purchase a new home for US$500,000. The bank requires a 20% downpayment which the Woodfields have in escrow. Recent sales of similar homes have sold for $450,000. Which describes the situation best?

A) Predatory lending.

B) Predatory borrowing.

C) Moral hazard between originator and investor.

D) Adverse selection between borrower and lender.

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The correct answer is B

Based on similar home sales, the Woodfields are overpaying for their home and borrowing too much.

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5、Examples of predatory lending include with of the following?

A) Inflating appraisals with cash-outs so the borrower cannot refinance.

B) Actual effective interest rates appear higher than they really are.

C) Lying on the mortgage application to purchase a more expensive home to refinance in the near future as prices appreciate.

D) Steering borrowers away from negative amortizing mortgages.

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The correct answer is A

Predatory lending is when actual rates are higher than they seem. Lying on a mortgage application to purchase a more expensive home to later refinance as prices appreciate describes predatory borrowing not lending. Negative amortizing mortgages are very aggressive arrangements where the low teaser-rates do not cover the actual interest expense and the differential accrues as principal.