Humber/Ontario Real Estate Course 3 Exam Practice

Which type of mortgage carries the highest lender risk?

1. A 10-year amortized loan

2. An interest-only mortgage with quarterly payments

3. An interest plus specified principal mortgage

4. An interest accruing mortgage

5. A fixed-rate mortgage with a 30-year term

6. A variable-rate mortgage

The correct answer is: An interest accruing mortgage

The interest accruing mortgage represents the highest lender risk primarily because the borrower does not make any principal payments during the life of the loan, which means the outstanding loan balance continues to grow. This type of mortgage allows interest to accumulate on the principal amount without reducing the loan balance. As a result, if the borrower defaults, the lender faces a higher amount owed than what was initially disbursed. The lender is at risk of greater losses, especially if the market value of the secured property has decreased. In contrast, other mortgage types either require periodic principal repayment or are structured in ways that mitigate lender risk. For example, a fixed-rate mortgage with a lengthy term typically involves regular principal and interest payments, lending more security to the lender as the principal balance decreases over time. An interest-only mortgage does allow for lower payments initially; however, it eventually requires a lump sum repayment of the principal, which can create financial strain if the borrower is unprepared. Other options like variable-rate mortgages may pose some risk due to interest fluctuations, but they usually include provisions for regular payments that contribute to reducing the principal. Hence, the structure and repayment terms of an interest accruing mortgage distinctly elevate the lender's exposure to loss over time.