A borrower took out a $400,000 mortgage and has paid $2,200 every month for five years. The balance owing is still exactly $400,000. Which repayment structure is this most likely to be?
Correct Answer
B) Interest-only mortgage
If five years of payments leave the balance exactly where it started, the payments covered interest only: $2,200 a month is roughly the interest on $400,000 at about 6.6%. A table or reducing mortgage would have reduced the balance.
Why This Is the Correct Answer
If five years of payments leave the balance exactly where it started, the payments covered interest only: $2,200 a month is roughly the interest on $400,000 at about 6.6%. Any table or reducing structure would have cut the balance.
Why the Other Options Are Wrong
Option A: Principal and interest table mortgage
Every table payment includes some principal, so after five years the balance would be noticeably below $400,000.
Option C: Reducing (flat principal) mortgage
A reducing mortgage repays a fixed amount of principal with each payment, so the balance falls from the very first payment.
Option D: Revolving credit with a reducing limit
A reducing limit forces the balance down each year, so it could not still be at the full $400,000.
Deep Analysis of This Finance Question
Tell mortgage structures apart by what happens to the balance. A table mortgage has level payments, mostly interest at first, so the balance falls slowly and then faster; after five years of a 30-year table loan roughly $20,000-$30,000 would be repaid. A reducing mortgage repays the same principal each time. An interest-only loan leaves the balance untouched until the interest-only period ends. An unchanged balance after five years is the signature of interest-only.
Background Knowledge for Finance
Mortgage structures in New Zealand include various payment arrangements. Interest-only mortgages allow borrowers to pay only interest for an initial period (typically 1-5 years), with principal repayments deferred. Principal and interest (table) mortgages require regular payments covering both interest and principal reduction. Reducing balance mortgages calculate interest on the outstanding balance, with payments reducing principal over time. Revolving credit mortgages function like large overdrafts with flexible payment arrangements. Understanding these structures is crucial for real estate agents advising clients on financing options and interpreting financial capacity.
Memory Technique
Picture the balance on a graph. Table and reducing loans slope downward; interest-only is a flat line until the interest-only period ends.
When a question gives the balance after some years, ask whether it moved at all. Any fall means principal was paid; no fall means interest-only.
Exam Tip for Finance
A small fall in the balance early in a long table loan is normal, so only an unchanged balance proves interest-only. Check the interest arithmetic: annual interest ≈ balance × rate.
Real World Application in Finance
An investor purchases a rental property with a $400,000 interest-only mortgage at 6.5% interest. Monthly payments of $2,167 cover interest only, maximizing tax deductions and preserving cash flow for property improvements or additional investments. After 5 years, they still owe the full $400,000 principal but have benefited from rental income and potential capital gains. As a real estate agent, understanding this helps explain to investor clients why their mortgage balance hasn't decreased despite years of payments.
Common Mistakes to Avoid on Finance Questions
- •Assuming all mortgages reduce principal equally over time
- •Not calculating expected principal reduction for comparison
- •Confusing revolving credit flexibility with interest-only structures
Related Topics & Key Terms
Key Terms:
More Finance Questions
What is the current standard LVR (Loan-to-Value Ratio) restriction for owner-occupier residential property purchases in New Zealand?
What is a key advantage of a revolving credit mortgage facility?
When assessing a mortgage application, which factor is typically given the highest priority by New Zealand lenders?
James has been contributing to KiwiSaver for 4 years and wants to withdraw funds for his first home. His KiwiSaver balance is $45,000, but $15,000 consists of government contributions and employer matching. What is the maximum he can withdraw for his house deposit?
What is the main advantage of a table mortgage compared to an interest-only mortgage?
- → What is the maximum amount a first home buyer can withdraw from their KiwiSaver account for a house deposit?
- → What does LVR stand for in New Zealand mortgage lending?
- → What is the key difference between a table mortgage and an interest-only mortgage in terms of monthly payments?
- → A bank checks how much of a borrower's gross income would go on debt repayments. The borrower earns $80,000 a year, already pays $800 a month on other debts, and the new mortgage would cost $2,200 a month. What share of gross income would the repayments take?
- → Sarah earns $80,000 annually and wants to borrow $400,000. What is her debt-to-income ratio?
- → A property is valued at $600,000 and the buyer has a $100,000 deposit. What LVR would this loan represent?
- → Which of the following is NOT typically considered by banks when assessing lending criteria?
- → How long must a KiwiSaver member have been contributing before they can withdraw funds for their first home?
- → Which type of mortgage allows borrowers to make additional payments that can be re-borrowed later?
- → A couple with a combined income of $120,000 wants to buy their first home for $650,000. They have a 15% deposit. What is their LVR?
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