NMLS Quiz: Identify Loan Defect Procedures
20 questions · exam conditions
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Identify Loan Defect ProceduresQuestion 1 of 20

During loan processing, an MLO discovers that the borrower's assets shown on bank statements include funds that were recently borrowed from a relative. What procedure should be followed?

Accept the funds as available assets since they are currently in the borrower's bank account
Exclude the borrowed funds from asset calculations and verify the borrower still meets requirements without them
Require the relative to sign a gift letter converting the borrowed funds to a gift for qualification
Include the borrowed amount as additional debt obligation in the debt-to-income ratio calculations instead
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NMLS Quiz

NMLS Quiz: Identify Loan Defect Procedures

Practice Identify Loan Defect Procedures in NMLS with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Identify Loan Defect Procedures, giving you a quick way to practice the rules, question types, and explanations that matter most for NMLS.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

During loan processing, an MLO discovers that the borrower's assets shown on bank statements include funds that were recently borrowed from a relative. What procedure should be followed?

  1. Accept the funds as available assets since they are currently in the borrower's bank account
  2. Exclude the borrowed funds from asset calculations and verify the borrower still meets requirements without them (correct answer)
  3. Require the relative to sign a gift letter converting the borrowed funds to a gift for qualification
  4. Include the borrowed amount as additional debt obligation in the debt-to-income ratio calculations instead
Explanation: Borrowed funds cannot be counted as assets for qualification purposes since they represent debt obligations. The MLO must exclude these funds and verify the borrower meets requirements with remaining assets. Option A violates lending guidelines. Option C circumvents the issue inappropriately. Option D is correct about debt treatment but doesn't address the asset issue.

Question 2

An MLO finds that the borrower's paystubs show a different employer than what's listed on the loan application. What is the required procedure?

  1. Update the application and obtain new employment verification from the actual employer (correct answer)
  2. Use the paystub information as sufficient employment verification without additional documentation
  3. Report the discrepancy as potential fraud since the borrower provided incorrect information
  4. Average the income from both employers to arrive at a conservative qualification estimate
Explanation: Employer discrepancies require updating the application and obtaining proper employment verification from the correct employer. This could be due to recent job changes, subsidiary relationships, or simple errors. Option B doesn't provide adequate verification. Option C assumes fraud without investigation. Option D doesn't address the employer identification issue.

Question 3

An MLO discovers that the loan file contains an outdated credit report that is now more than 90 days old. What corrective action is required?

  1. Proceed with the existing credit report since it was valid at application
  2. Order an updated credit report and re-evaluate the borrower's current creditworthiness (correct answer)
  3. Extend the validity through a credit monitoring service supplement for current status
  4. Obtain a credit score refresh without the full report to verify score changes
Explanation: Credit reports older than 90 days typically require updating to ensure current creditworthiness evaluation. This protects both lender and borrower by using current information for qualification. Option A uses stale information. Option C and D don't provide complete current credit information needed for proper evaluation.

Question 4

During loan processing, an MLO discovers that the borrower's employment verification shows a different salary than what was reported on the application. What should the MLO do first?

  1. Contact the borrower to clarify the discrepancy and obtain updated income documentation for verification (correct answer)
  2. Use the lower of the two salary figures to ensure conservative underwriting without further investigation
  3. Report the discrepancy to the state regulatory agency as potential fraud before proceeding further
  4. Deny the loan application immediately due to material misrepresentation on the original application
Explanation: The MLO should first contact the borrower to clarify the discrepancy, as it could be due to various legitimate reasons (bonus vs. base pay, recent raise, etc.). Updated documentation should be obtained to verify the correct income. Option B makes assumptions without investigation. Option C is premature without first attempting clarification. Option D is too hasty and doesn't allow for legitimate explanations.

Question 5

During final loan review, an MLO discovers that required mortgage insurance was not included in the loan package for a high LTV loan. What corrective action must be taken?

  1. Obtain mortgage insurance quotes and update loan disclosures with premium calculations (correct answer)
  2. Increase the down payment requirement to reach an acceptable loan-to-value ratio
  3. Proceed without mortgage insurance but increase the interest rate for additional risk
  4. Convert the loan to a government program with built-in mortgage insurance coverage
Explanation: Required mortgage insurance must be obtained and included in payment calculations with updated disclosures provided to the borrower. This ensures compliance with lending guidelines and proper borrower notification. Option B changes agreed terms. Option C violates lending requirements. Option D may change fundamental loan terms without borrower agreement.

Question 6

During loan processing, an MLO finds that the homeowner's insurance policy doesn't meet the lender's minimum coverage requirements. What corrective action should be taken?

  1. Proceed with the existing policy and obtain additional coverage through private mortgage insurance to supplement protection
  2. Require the borrower to increase the coverage amount or obtain a different policy that meets requirements (correct answer)
  3. Reduce the loan amount proportionally to match the available insurance coverage limits for the property
  4. Purchase force-placed insurance immediately and add the premium cost to the borrower's monthly payment
Explanation: The borrower must obtain adequate homeowner's insurance that meets the lender's requirements before closing. This protects both parties' interests in the property. Option A incorrectly suggests PMI covers property damage. Option C unnecessarily reduces the loan. Option D is premature - force-placed insurance is used only when borrowers fail to maintain required coverage after closing.

Question 7

An MLO finds that the property's legal description on the purchase contract differs from the title report. What corrective action should be taken?

  1. Use the title company's legal description since it is based on official recorded documents and surveys
  2. Obtain clarification and correction from the appropriate parties to ensure all documents reflect the same property (correct answer)
  3. Proceed with closing using the purchase contract description as it represents the parties' intent to purchase
  4. Order a new survey to determine which legal description is accurate and update all documents accordingly
Explanation: Discrepancies in legal descriptions must be resolved by obtaining clarification and ensuring all documents refer to the same property. This prevents future title issues and ensures clear ownership transfer. Options A and C arbitrarily choose one description without verification. Option D may be one solution but doesn't address the need for document coordination.

Question 8

During final loan review, an MLO notices that the credit report shows a new credit inquiry and account opening that occurred after the initial application. What action should be taken?

  1. Proceed with the original loan approval since the new account was opened after underwriting approval
  2. Order an updated credit report and re-verify the borrower's debt-to-income ratio with the new account (correct answer)
  3. Automatically increase the interest rate by 0.25% to compensate for the additional credit risk exposure
  4. Require the borrower to close the new account immediately and provide proof of closure before funding
Explanation: A new credit account discovered before closing requires an updated credit report and recalculation of the debt-to-income ratio to ensure the borrower still qualifies. This protects both lender and borrower. Option A ignores changed financial circumstances. Option C arbitrarily changes terms without proper analysis. Option D may be unnecessarily restrictive if the borrower still qualifies.

Question 9

An MLO discovers that the borrower has undisclosed liabilities that significantly impact creditworthiness. What is the required corrective action?

  1. Update the loan application to reflect the correct liabilities and re-run the qualification analysis completely (correct answer)
  2. Increase the required down payment percentage to compensate for the additional debt obligations discovered
  3. Approve the loan with additional conditions requiring monthly financial reporting from the borrower post-closing
  4. Transfer the application to a subprime lending division that specializes in borrowers with credit issues
Explanation: Undisclosed liabilities require updating the application and re-running qualification calculations to determine if the borrower still meets guidelines. This ensures accurate risk assessment. Option B arbitrarily changes terms without proper analysis. Option C creates ongoing monitoring that's unusual for standard loans. Option D may be unnecessary if borrower still qualifies.

Question 10

An MLO discovers that the borrower's bank statements show several large deposits that weren't disclosed on the application. What is the appropriate procedure?

  1. Request a letter of explanation for each deposit and source documentation to verify the funds' origin (correct answer)
  2. Reduce the loan amount by the total of the undisclosed deposits as a penalty for non-disclosure
  3. Report the borrower to the Consumer Financial Protection Bureau for application fraud immediately
  4. Accept the deposits as additional assets that improve the borrower's financial position for qualification
Explanation: Large undisclosed deposits require investigation through letters of explanation and source documentation to ensure they're from acceptable sources (not borrowed funds). This is standard underwriting procedure. Option B penalizes without investigation. Option C is premature before determining the source. Option D accepts potentially problematic funds without verification.

Question 11

An MLO finds that the borrower's credit score has dropped significantly since the initial application due to new derogatory information. What action should be taken?

  1. Re-evaluate the loan under current credit guidelines and determine if the borrower still qualifies for approval (correct answer)
  2. Proceed with the original approval since the credit was acceptable at the time of application submission
  3. Require additional collateral to secure the loan due to the decreased creditworthiness of the borrower
  4. Automatically increase the interest rate by 0.5% to compensate for the additional risk without re-underwriting
Explanation: Significant credit score changes require re-evaluation under current guidelines to determine continued qualification. This protects both lender and borrower from inappropriate loans. Option B ignores material changes in creditworthiness. Option C adds requirements without proper analysis. Option D arbitrarily changes terms without determining if the borrower qualifies.

Question 12

An MLO notices that the purchase contract price differs from the price shown on the loan application by $5,000. What procedure should be followed?

  1. Use the contract price as correct and update all loan calculations accordingly
  2. Split the difference between the two prices to arrive at a compromise figure
  3. Proceed with the application price since it was the basis for original approval
  4. Obtain clarification from the borrower and update documentation throughout as needed (correct answer)
Explanation: Price discrepancies require clarification from the borrower to determine the correct amount, followed by updating all relevant documentation. The purchase price affects LTV calculations, loan amounts, and other key factors. Option A assumes the contract is correct without verification. Option B uses an arbitrary compromise. Option C ignores potential impacts of the difference.

Question 13

An MLO discovers that the interest rate lock has expired and current rates are higher than the locked rate. What corrective procedure should be implemented?

  1. Honor the original locked rate since the borrower relied on it when signing the purchase contract
  2. Provide the borrower options including extending the lock, accepting current rates, or paying lock extension fees (correct answer)
  3. Automatically apply the current market rate and notify the borrower of the change before closing
  4. Cancel the loan application and require the borrower to reapply under current rate and term conditions
Explanation: When a rate lock expires, the MLO should present options to the borrower, which may include lock extensions (possibly with fees), accepting current rates, or other alternatives per lender policy. This gives borrowers choice and transparency. Option A may not be required by contract. Option C unilaterally changes terms. Option D is unnecessarily drastic.

Question 14

An MLO discovers that the flood determination shows the property is in a Special Flood Hazard Area, but no flood insurance was included in the loan package. What corrective action is required?

  1. Obtain flood insurance quotes and add the annual premium to the borrower's escrow account calculations (correct answer)
  2. Advise the borrower that flood insurance is optional but recommended for properties in flood zones
  3. Increase the down payment requirement by 5% to offset the additional risk of flood damage
  4. Transfer the loan to a portfolio lender that specializes in high-risk flood zone properties
Explanation: Flood insurance is mandatory for properties in Special Flood Hazard Areas when the loan is from a federally regulated lender. The MLO must obtain flood insurance and include the premium in escrow calculations. Option B incorrectly states it's optional. Option C doesn't address the insurance requirement. Option D is unnecessary and doesn't solve the compliance issue.

Question 15

An MLO notices that the loan file is missing required income documentation that was supposed to be provided by the borrower. What is the appropriate corrective action?

  1. Contact the borrower immediately to obtain the missing documentation before proceeding with underwriting review (correct answer)
  2. Estimate the missing income information based on similar borrowers in the same occupation and geographic area
  3. Proceed with a reduced loan amount that qualifies based on the income documentation currently available
  4. Submit the loan to underwriting with a note explaining the missing documentation and requesting an exception
Explanation: Missing required documentation must be obtained from the borrower before proceeding. Complete documentation is necessary for proper underwriting and regulatory compliance. Option B uses impermissible estimates. Option C changes terms without borrower agreement. Option D submits an incomplete file which violates underwriting requirements.

Question 16

An MLO discovers that the property survey shows an encroachment issue that wasn't previously disclosed. What corrective action is required?

  1. Obtain title insurance with specific coverage for the encroachment issue and proceed to closing as scheduled
  2. Require resolution of the encroachment through legal action or boundary adjustment before closing can occur
  3. Reduce the appraised value proportionally to account for the encroachment and adjust the loan amount accordingly
  4. Notify all parties and determine appropriate resolution which may include insurance, legal remedy, or other solutions (correct answer)
Explanation: Encroachment issues require notification of all parties and determination of appropriate resolution, which could include title insurance coverage, legal remedies, boundary adjustments, or other solutions depending on severity and impact. Option A assumes insurance is sufficient without analysis. Option B may be unnecessarily restrictive. Option C arbitrarily adjusts value without proper consideration.

Question 17

An MLO notices that the loan application shows conflicting occupancy information between different sections of the form. What procedure should be followed?

  1. Use the occupancy designation that results in the most favorable loan terms and pricing for the borrower
  2. Clarify the borrower's actual intended occupancy and correct all inconsistencies in the file (correct answer)
  3. Default to primary residence designation since it is the most common occupancy type used
  4. Submit the loan with both designations noted and let underwriting determine the classification
Explanation: Occupancy inconsistencies must be clarified with the borrower and corrected throughout the file since occupancy affects loan terms, rates, and requirements. Accurate occupancy designation is crucial for proper pricing and compliance. Options A and C make arbitrary assumptions. Option D passes an incomplete file to underwriting.

Question 18

During final review, an MLO discovers that the borrower's employment verification shows the borrower was terminated last week. What immediate action is required?

  1. Proceed with closing since the loan was approved based on employment at the time of application
  2. Suspend the loan processing and re-verify the borrower's ability to repay without employment income (correct answer)
  3. Convert the loan to a stated income program to avoid employment verification requirements completely
  4. Require immediate payment of six months of mortgage payments in escrow as security for unemployment
Explanation: Job loss before closing fundamentally changes the borrower's ability to repay and requires immediate suspension and re-evaluation. The lender must assess whether the borrower can still qualify. Option A ignores changed circumstances. Option C may not be available and doesn't address ability to repay. Option D creates arbitrary requirements.

Question 19

An MLO finds that a title report shows an unreleased lien that the seller claims was paid off three years ago. What is the most appropriate corrective action?

  1. Accept the seller's verbal statement and proceed to closing with a standard title insurance policy
  2. Require the seller to obtain a satisfaction of lien document and have it recorded before closing (correct answer)
  3. Increase the title insurance coverage amount to protect against potential lien enforcement actions
  4. Advise the buyer to purchase an extended title insurance policy to cover all possible title defects
Explanation: An unreleased lien must be properly satisfied and recorded to clear the title. The seller must obtain and record a satisfaction of lien document before closing can proceed. Option A ignores the title defect. Option C doesn't resolve the underlying problem. Option D doesn't address the specific lien issue that needs to be cleared.

Question 20

An MLO discovers that the loan application contains conflicting information between the borrower's stated income and tax returns. What procedure should be followed?

  1. Use the tax return figures as they are official IRS documents and adjust the loan amount accordingly
  2. Obtain a detailed explanation from the borrower and additional documentation to reconcile the differences completely (correct answer)
  3. Average the two income figures to arrive at a conservative estimate for underwriting qualification purposes
  4. Refer the application to the fraud department and suspend all processing until investigation is completed
Explanation: Income discrepancies require investigation through borrower explanation and additional documentation. There may be legitimate reasons (business deductions, timing differences, etc.). Proper verification ensures accurate underwriting. Option A ignores potential valid explanations. Option C uses arbitrary calculations. Option D assumes fraud without investigation.