Real Estate ExamStudy Topic
Real Estate Finance Study Guide for the Licensing Exam
Study real estate finance for your licensing exam. Covers mortgage types, FHA and VA loans, TILA, RESPA, LTV, PMI, and loan amortization basics.
Topic Overview
Mortgage basics: A mortgage (or deed of trust in some states) is a security instrument that pledges real property as collateral for a loan. In a mortgage state, the borrower (mortgagor) conveys a lien to the lender (mortgagee); in a deed of trust state, a trustor (borrower) conveys bare legal title to a trustee, with the lender as beneficiary. The distinction matters because deed of trust states typically allow non-judicial foreclosure (faster and less expensive for lenders), while mortgage states may require judicial foreclosure through the courts.
Types of loans tested on the real estate exam include: conventional loans (not insured by a federal agency; conforming loans meet Fannie Mae/Freddie Mac standards for purchase in the secondary market); FHA loans (insured by the Federal Housing Administration, allowing lower down payments of 3.5% for qualifying borrowers, requiring upfront and annual mortgage insurance premiums); VA loans (guaranteed by the Department of Veterans Affairs for eligible service members and veterans, often with no down payment required); and USDA rural development loans (for qualifying rural properties with income limits). Adjustable-rate mortgages (ARMs) have an interest rate that adjusts periodically based on an index plus a margin; key terms include initial rate, adjustment period, index, margin, caps (per-adjustment and lifetime).
Federal lending laws protect borrowers and ensure fair access to credit. The Truth in Lending Act (TILA) requires lenders to disclose the annual percentage rate (APR), total finance charges, and loan terms to borrowers. The Real Estate Settlement Procedures Act (RESPA) requires lenders to provide a Loan Estimate (LE) within three business days of application and a Closing Disclosure (CD) at least three business days before closing, prohibits kickbacks and unearned fees, and limits escrow account surpluses. The Equal Credit Opportunity Act (ECOA) prohibits lenders from discriminating against applicants based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance income.
Loan-to-value ratio (LTV) is the loan amount divided by the appraised value or purchase price (whichever is lower). A $180,000 loan on a $200,000 property has an LTV of 90%. Lenders typically require private mortgage insurance (PMI) on conventional loans with LTV over 80%. PMI protects the lender if the borrower defaults; it is not the same as homeowner's insurance. PMI can be cancelled when the LTV drops to 80% based on the original amortization schedule, or at the lender's discretion when LTV reaches 80% based on current value, under the Homeowners Protection Act.
Amortization is the process of paying off a loan through regular principal and interest payments over the loan term. With a fully amortized fixed-rate mortgage, each monthly payment covers the interest accrued since the last payment plus a portion of principal; early payments are mostly interest, and the principal portion increases over time. A 30-year amortization table question requires understanding that a $100,000 loan at 6% for 30 years has a monthly payment of approximately $599.55 -- and that after many payments, the remaining balance is still substantial because early payments barely touch principal.
- Confusing the mortgagor and mortgagee; the mortgagor is the borrower who pledges the property as collateral, while the mortgagee is the lender who receives the lien. A common memory trick: the mortgagOR is the one who OWES (both end in 'or').
- Mixing up TILA and RESPA disclosure requirements; TILA requires disclosure of APR and total finance charges (the cost of credit), while RESPA governs settlement procedures and prohibits kickbacks. They overlap in the TRID (TILA-RESPA Integrated Disclosure) forms used today.
- Assuming FHA mortgage insurance can always be cancelled after LTV drops below 80%; for FHA loans originated after June 2013 with less than 10% down, MIP is required for the life of the loan, unlike conventional PMI which cancels at 80% LTV.
- Forgetting that the LTV calculation uses the lower of appraised value or purchase price, not just the purchase price; if the property appraises below the contract price, the LTV is calculated on the appraised value.
- Confusing the Loan Estimate and the Closing Disclosure timelines; the Loan Estimate must be provided within three business days of receiving a completed loan application, and the Closing Disclosure must be delivered at least three business days before consummation of the loan.
- Treating PMI and homeowner's insurance as interchangeable; PMI protects the lender in the event of borrower default, while homeowner's insurance protects the property owner against property damage and liability.
Checkpoint Quiz
Test your understanding of Real Estate Finance
These questions are for study practice only and are not official exam questions.
1. A borrower takes out a $200,000 mortgage at a 6% annual interest rate. What is the interest charged for the FIRST month?
2. Loan-to-value ratio (LTV) is calculated as:
3. Which type of mortgage has a fixed interest rate for the entire loan term?
4. One discount point paid at closing is equal to:
5. A buyer purchases a home for $250,000 and makes a $50,000 down payment. The lender charges 2 discount points. How much does the buyer pay in points?
6. Private mortgage insurance (PMI) is typically required when the LTV ratio exceeds:
7. Which federal law requires lenders to disclose the Annual Percentage Rate (APR) to borrowers?
8. An amortizing mortgage has equal monthly payments, but in the early years most of each payment goes toward:
9. A seller agrees to finance the buyer's purchase by accepting monthly payments instead of a lump sum from a lender. This arrangement is called a:
10. A borrower has a $400,000 loan at 7.5% annual interest. What is the interest for the first month, and what portion of a $2,797 monthly payment reduces principal?
Frequently asked questions
What is the difference between a mortgage and a deed of trust?
A mortgage is a two-party security instrument in which the borrower (mortgagor) gives the lender (mortgagee) a lien on the property. A deed of trust is a three-party instrument in which the borrower (trustor) conveys bare legal title to a neutral trustee to hold for the benefit of the lender (beneficiary). Deed of trust states typically allow faster non-judicial foreclosure, while mortgage states often require court involvement.
What does the annual percentage rate (APR) represent?
The APR is the true cost of borrowing expressed as a yearly rate, including the interest rate plus most loan fees and costs (such as origination fees and mortgage insurance premiums), but not property taxes, homeowner's insurance, or title fees. Because it includes fees, the APR is always equal to or higher than the note rate. TILA requires lenders to disclose the APR to borrowers.
What is RESPA and what does it prohibit?
RESPA (Real Estate Settlement Procedures Act) governs federally related mortgage loans. It requires lenders to provide a Loan Estimate within three business days of application and a Closing Disclosure three business days before closing. It prohibits kickbacks and referral fees between settlement service providers, limits escrow account amounts, and requires disclosure of affiliated business arrangements.
What is private mortgage insurance (PMI) and when is it required?
PMI is insurance that protects the lender if the borrower defaults on a conventional mortgage. It is required when the loan-to-value ratio exceeds 80 percent at origination. PMI must be cancelled automatically when the LTV reaches 78 percent based on the original amortization schedule under the Homeowners Protection Act, and borrowers can request cancellation at 80 percent LTV.
What is the difference between FHA mortgage insurance and conventional PMI?
FHA mortgage insurance (MIP) is required on all FHA loans regardless of down payment amount, and consists of an upfront premium (typically 1.75% of the loan amount) plus annual premiums. For FHA loans originated after June 2013 with less than 10% down, MIP remains for the life of the loan. Conventional PMI can be cancelled once LTV reaches 80 percent. FHA MIP rates and terms change periodically; confirm current requirements with FHA.
