Comprehensive Study Guide
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Overview
This study guide covers the financing and loan concepts tested on the California Real Estate Salesperson Exam. Topics include loan types, government-backed programs, financing instruments, key calculations, and federal lending regulations. Mastery of these concepts is essential, as finance questions represent a significant portion of the exam.
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Loan Types & Characteristics
Core Loan Structures
| Loan Type | Key Feature | Payment Structure |
|---|---|---|
| Fully Amortized Fixed-Rate | Fixed rate, equal payments | Principal + Interest each payment |
| Straight (Term) Loan | Interest-only during term | Entire principal due at maturity |
| Balloon Payment Loan | Short term, long amortization schedule | Large lump-sum at end |
| Growing Equity Mortgage (GEM) | Increasing payments over time | Extra amounts go to principal only |
Specialized Loan Types
• Fully Amortized Fixed-Rate Loan: The most common loan type. Equal monthly payments cover both principal and interest. The loan is completely paid off by the final payment with no remaining balance.
• Balloon Payment Loan: Payments may appear normal (often calculated on a 30-year schedule), but at the end of a short term (e.g., 5 or 7 years), the entire remaining principal balance is due in one large "balloon" payment.
• Straight (Term) Loan: The borrower pays only interest during the loan term. The full original principal is due at maturity. Historically used in pre-Depression era; less common today.
• Reverse Mortgage: Converts home equity into cash for homeowners aged 62 or older. No monthly payments are required. The loan is repaid when the borrower sells, moves out permanently, or dies. The lender holds a lien on the property.
• Package Mortgage: Uses both real property AND personal property (appliances, furniture) as collateral in a single loan. Common in furnished properties or new home sales with included appliances.
• Purchase Money Mortgage: Seller financing — the seller acts as the lender, carrying back all or part of the purchase price. The buyer gives the seller a promissory note and deed of trust (or mortgage) instead of paying cash.
• Growing Equity Mortgage (GEM): Payments increase on a predetermined schedule. The increased payment amounts are applied entirely to principal, not interest, resulting in a significantly shorter loan term.
Key Terms – Loan Types
• Amortization: The gradual reduction of loan principal through scheduled payments
• Balloon Payment: A final, large lump-sum payment of remaining principal
• Equity: The difference between a property's market value and the amount owed on it
• Term: The length of time for loan repayment
⚠️ Watch Out For
• A balloon payment loan is NOT the same as a straight loan. A balloon loan has payments that include some principal; a straight loan has interest-only payments.
• Reverse mortgages do NOT eliminate the mortgage. The debt grows over time as interest accrues; it is simply deferred until a triggering event (sale, move-out, or death).
• A GEM looks like a fixed-rate loan but is not — payments increase over time.
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Government-Backed & Conventional Loans
FHA Loans
• Insured by the Federal Housing Administration (FHA)
• The FHA does not lend money — it insures approved lenders against borrower default
• Available to any qualified borrower meeting credit and income standards
• Minimum down payment: 3.5% for borrowers with a credit score of 580 or higher
• Maximum LTV: 96.5%
• Requires Mortgage Insurance Premium (MIP) regardless of down payment amount
VA Loans
• Guaranteed by the Department of Veterans Affairs
• Available only to eligible veterans, active-duty service members, and surviving spouses
• Often allows 0% down payment (no down payment required for eligible borrowers)
• No private mortgage insurance (PMI) required
• VA guarantees a portion of the loan, not the full amount
CalVet Loans
• A California state program for eligible California veterans
• The state holds title to the property under a land contract (contract for deed) until the loan is fully paid off
• The veteran is the equitable owner with the right to use the property
• Unique to California — a common exam topic
Conventional Loans & PMI
• Conventional loans are not government-insured or guaranteed
• Private Mortgage Insurance (PMI): Required on conventional loans when the borrower's down payment is less than 20% (LTV exceeds 80%)
• PMI protects the lender (not the borrower) in case of default
• PMI can be canceled once the borrower reaches 20% equity (per the Homeowners Protection Act)
Key Terms – Government Loans
• FHA (Federal Housing Administration): Insures loans; does not make them
• VA (Department of Veterans Affairs): Guarantees loans for eligible veterans
• CalVet: California veteran loan program where state holds title
• MIP (Mortgage Insurance Premium): FHA's version of mortgage insurance
• PMI (Private Mortgage Insurance): Required on conventional loans with LTV > 80%
• LTV (Loan-to-Value Ratio): Loan amount ÷ property value
⚠️ Watch Out For
• The FHA insures loans; the VA guarantees loans — these are different mechanisms but serve a similar lender-protection purpose.
• CalVet is unique: The state holds legal title; the veteran holds equitable title. This is the opposite of most loan arrangements.
• PMI protects the lender, not the borrower — a frequently tested distinction.
• FHA loans require MIP regardless of down payment size, unlike PMI which is removed at 80% LTV.
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Financing Instruments & Legal Concepts
Mortgage vs. Deed of Trust
| Feature | Mortgage | Deed of Trust |
|---|---|---|
| Parties | 2 (Mortgagor & Mortgagee) | 3 (Trustor, Trustee, Beneficiary) |
| Foreclosure Type | Judicial (court required) | Non-judicial (Trustee's Sale) |
| Speed of Foreclosure | Slower | Faster |
| Used in California? | Rarely | Primarily YES |
• Mortgagor = Borrower (gives the mortgage)
• Mortgagee = Lender (receives the mortgage)
• Trustor = Borrower (gives the deed of trust)
• Trustee = Neutral third party (holds title)
• Beneficiary = Lender (benefits from the security)
Critical Clauses in Financing Documents
• Alienation Clause (Due-on-Sale Clause): Requires the borrower to pay off the entire loan balance when the property is sold or transferred. Prevents loan assumption without lender approval. Protects the lender from below-market interest rate loans being transferred.
• Acceleration Clause: Gives the lender the right to demand immediate full repayment if the borrower defaults or violates loan terms. This clause is what allows a lender to start foreclosure proceedings.
• Subordination Clause: Allows a later-recorded deed of trust to take priority over an earlier one. Commonly used when a land purchase loan agrees to be subordinated to a future construction loan (so the construction lender gets first position).
Key Financing Concepts
• Hypothecation: Pledging property as collateral for a loan without surrendering possession or title. The borrower continues to use the property while the lender holds a security interest. This is how all standard mortgages work.
• Non-judicial Foreclosure (Trustee's Sale): Because California uses deeds of trust, lenders can foreclose without going to court, making the process faster. The trustee conducts the sale.
• Purchase Money Mortgage: Any mortgage given to a seller as part of the purchase price. The seller becomes the lender.
Key Terms – Financing Instruments
• Promissory Note: The borrower's written promise to repay the debt (the "IOU")
• Deed of Trust: The security instrument pledging the property as collateral
• Trustor: Borrower in a deed of trust arrangement
• Beneficiary: Lender in a deed of trust arrangement
• Trustee: Neutral third party holding title in trust
• Alienation Clause: Due-on-sale provision requiring full payoff upon transfer
• Acceleration Clause: Lender's right to demand full repayment upon default
• Subordination Clause: Allows junior lien to take priority over senior lien
• Hypothecation: Pledging collateral without surrendering possession
⚠️ Watch Out For
• California primarily uses deeds of trust, not mortgages — know the three-party structure cold.
• The alienation clause and acceleration clause are different: alienation is triggered by sale/transfer; acceleration is triggered by default.
• Hypothecation simply means the borrower keeps the property while using it as collateral — this is standard in all real estate lending.
• A subordination clause lowers a lien's priority — remember it's used to benefit construction lenders.
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Key Calculations & Costs
Loan-to-Value (LTV) Ratio
Formula:
$$\text{LTV} = \frac{\text{Loan Amount}}{\text{Appraised Value or Purchase Price (lower of the two)}} \times 100$$
Example: $200,000 loan ÷ $250,000 property value = 80% LTV
• Higher LTV = more risk to lender
• LTV above 80% typically triggers PMI requirement on conventional loans
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Discount Points
• 1 discount point = 1% of the loan amount
• Points are prepaid interest paid at closing
• Paying points lowers the interest rate on the loan
• Example: 2 points on a $300,000 loan = $6,000 paid at closing in exchange for a lower rate
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Annual Interest Calculation
Formula:
$$\text{Annual Interest} = \text{Principal Balance} \times \text{Annual Interest Rate}$$
Example: $300,000 × 0.06 = $18,000 in first-year interest
> Note: This formula applies to the first year or when calculating interest on a specific balance. In a fully amortized loan, the interest portion decreases as principal is paid down.
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Front-End (Housing) Ratio
Formula:
$$\text{Max PITI} = \text{Gross Monthly Income} \times \text{Front-End Ratio (28\%)}$$
Example: $6,000 × 0.28 = $1,680 maximum monthly PITI
• PITI = Principal + Interest + Taxes + Insurance
• Conventional guideline: 28% of gross monthly income
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Back-End (Debt-to-Income) Ratio
Formula:
$$\text{Max Total Debt} = \text{Gross Monthly Income} \times \text{Back-End Ratio (43\%)}$$
Example: $6,000 × 0.43 = $2,580 maximum total monthly debt
• Includes all monthly debts: housing, car payments, credit cards, student loans, etc.
• Conventional lenders typically require 43% or less
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Summary: Key Ratios at a Glance
| Ratio | Type | Standard Limit | What It Measures |
|---|---|---|---|
| LTV | Loan-to-Value | 80% (conventional) | Risk to lender |
| Front-End | Housing Ratio | 28% | Housing costs vs. income |
| Back-End | DTI | 43% | All debts vs. income |
⚠️ Watch Out For
• LTV always uses the lower of appraised value or purchase price — not both.
• Points lower the rate but increase upfront costs — a trade-off borrowers must evaluate.
• The front-end ratio covers PITI — taxes and insurance are included, not just principal and interest.
• Gross income (before taxes) is always used for qualifying ratios, never net income.
• In amortized loans, the interest portion decreases each month as principal is reduced — the first-year formula does not apply to later years.
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Lending Regulations & Disclosures
Truth-in-Lending Act (TILA) – Regulation Z
• Purpose: Ensures borrowers can compare loan costs
• Required Disclosures:
- Annual Percentage Rate (APR) — true cost of borrowing, including fees
- Total finance charges
- Total amount financed
- Total of all payments
• APR is almost always higher than the stated interest rate because it includes fees
Real Estate Settlement Procedures Act (RESPA)
• Purpose: Transparency in closing costs and prohibition of kickbacks
• Key Requirements:
- Loan Estimate: Provided within 3 business days of loan application
- Closing Disclosure: Provided at least 3 business days before closing
- Prohibits kickbacks and unearned fees between settlement service providers
- Prohibits required use of affiliated service providers
Equal Credit Opportunity Act (ECOA)
• Purpose: Prohibits discrimination in credit decisions
• Protected Classes: Race, color, religion, national origin, sex, marital status, age, receipt of public assistance
• Applies to all credit transactions, not just real estate
• Lenders must provide written notice if a loan application is denied
Fair Housing Act & Redlining
• Redlining: Illegal practice of refusing loans or services in geographic areas based on the racial or ethnic composition of neighborhoods
• Prohibited under the Fair Housing Act and the Community Reinvestment Act (CRA)
• Modern redlining can include denying insurance, appraisals, or other services — not just loans
Community Reinvestment Act (CRA)
• Purpose: Requires federally insured banks and savings institutions to meet the credit needs of ALL segments of their communities
• Specifically targets low- and moderate-income neighborhoods
• Combats the effects of discriminatory lending practices
• Banks receive CRA ratings that affect regulatory approvals
The Secondary Mortgage Market
• Primary Market: Where loans are originated between lenders and borrowers
• Secondary Market: Where existing loans are bought and sold among investors
• Purpose: Replenishes lenders' funds so they can make new loans, providing liquidity to the mortgage market
| Entity | Full Name | Role |
|---|---|---|
| Fannie Mae | Federal National Mortgage Association (FNMA) | Purchases and securitizes conventional and FHA/VA loans |
| Freddie Mac | Federal Home Loan Mortgage Corporation (FHLMC) | Purchases and securitizes conventional loans |
| Ginnie Mae | Government National Mortgage Association (GNMA) | Guarantees securities backed by FHA/VA loans |
Key Terms – Regulations
• APR (Annual Percentage Rate): True cost of borrowing including fees; required TILA disclosure
• Loan Estimate: RESPA document provided within 3 days of application
• Closing Disclosure: RESPA document provided 3 days before closing
• ECOA: Prohibits credit discrimination based on protected characteristics
• Redlining: Illegal geographic discrimination in lending
• CRA: Requires banks to serve all community segments
• Secondary Market: Where loans are bought and sold after origination
• Fannie Mae / Freddie Mac: Dominant purchasers in the secondary market
• Securitization: Bundling mortgages into investment securities
⚠️ Watch Out For
• TILA/Regulation Z focuses on disclosure of loan costs; RESPA focuses on closing cost transparency and prohibiting kickbacks — they serve different purposes.
• APR ≠ Interest Rate. APR includes fees and is always higher than the note rate.
• Fannie Mae and Freddie Mac do NOT make loans — they purchase loans already made by primary lenders.
• ECOA covers all credit, not just mortgages; the Fair Housing Act specifically covers housing-related discrimination.
• Redlining violates both the Fair Housing Act and the CRA — know both laws.
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Quick Review Checklist
Before your exam, confirm you can answer YES to each of the following:
Loan Types
• [ ] I can distinguish between a fully amortized, straight, balloon, and GEM