Overview
Real estate finance is one of the most heavily tested areas on the Texas Real Estate Salesperson Exam. This guide covers mortgage instruments, loan types, federal consumer protection laws, loan qualification standards, and the secondary mortgage market. Mastering these concepts will prepare you to identify key documents, calculate financial ratios, and understand the regulatory framework governing real estate transactions.
---
Mortgage Instruments & Documents
Core Concept
Every real estate loan involves two distinct elements: the debt instrument (the promise to repay) and the security instrument (collateral protecting the lender). Understanding the difference between these documents—and how they interact—is fundamental.
The Two Key Documents in Every Loan
• Promissory Note (Mortgage Note): The borrower's written, legally binding personal promise to repay the debt under specified terms. This is the debt instrument.
• Deed of Trust / Mortgage: The security instrument that pledges the property as collateral for the debt.
Mortgage vs. Deed of Trust
| Feature | Mortgage | Deed of Trust |
|---|---|---|
| Number of parties | Two (borrower + lender) | Three (trustor, beneficiary, trustee) |
| Who holds title | Lender holds lien | Trustee holds legal title |
| Foreclosure method | Judicial (court required) | Non-judicial (faster) |
| Texas preference | Less common | Standard in Texas |
• Trustor: The borrower
• Beneficiary: The lender
• Trustee: A neutral third party who holds legal title until the loan is repaid
Critical Mortgage Clauses
• Acceleration Clause: Allows the lender to declare the entire remaining loan balance immediately due and payable upon borrower default. This is triggered by non-payment or breach of loan terms.
• Due-on-Sale Clause (Alienation Clause): Requires full loan repayment when the property is sold or transferred. Prevents buyers from assuming the loan without lender approval.
• Subordination Clause: Allows a mortgage or lien to be placed in a lower priority position than a subsequent lien. Commonly used during refinancing when a second mortgage remains in place.
Foreclosure Terms
• Deficiency Judgment: A court order requiring the borrower to pay the difference between the foreclosure sale price and the remaining loan balance when sale proceeds are insufficient to cover the debt.
Key Terms
• Trustor – borrower in a deed of trust
• Beneficiary – lender in a deed of trust
• Trustee – neutral third party holding title in a deed of trust
• Promissory Note – personal promise to repay (the debt itself)
• Alienation Clause – another name for the due-on-sale clause
• Deficiency Judgment – court order for remaining debt after foreclosure sale
⚠️ Watch Out For
• Texas uses deeds of trust, not traditional mortgages, in most transactions. Exam questions will test whether you know the three-party structure.
• Do not confuse the promissory note (the debt/promise) with the deed of trust (the security/collateral pledge). They are separate documents.
• The acceleration clause and due-on-sale clause are different: acceleration is triggered by default; due-on-sale is triggered by transfer of property.
---
Loan Types & Characteristics
Conventional Loans
• Not insured or guaranteed by any government agency (FHA, VA, or USDA)
• Based solely on borrower creditworthiness and property value
• PMI required if down payment is less than 20% (LTV above 80%)
Government-Backed Loans
| Loan Type | Down Payment | PMI/Insurance | Key Feature |
|---|---|---|---|
| FHA | 3.5% minimum | MIP for life of loan (if <10% down) | Max 96.5% LTV |
| VA | 0% required | No PMI | Funding fee charged; veterans only |
| USDA | 0% required | Guarantee fee | Rural areas; income limits apply |
• FHA Mortgage Insurance Premium (MIP): If down payment is less than 10%, MIP is required for the life of the loan. If 10% or more, MIP can be removed after 11 years.
• VA Funding Fee: A one-time fee charged in lieu of PMI; can be financed into the loan.
Fixed-Rate vs. Adjustable-Rate Mortgages
| Feature | Fixed-Rate | ARM (Adjustable-Rate) |
|---|---|---|
| Interest rate | Constant for entire term | Changes periodically based on an index |
| Monthly payment | Predictable/stable | Fluctuates |
| Risk to borrower | Low | Higher (payment shock possible) |
Specialty Loan Types
• Balloon Mortgage: Smaller periodic payments (often partially amortized or interest-only) with a large lump-sum payment due at the end of a short term. Risk: borrower may be unable to refinance or repay.
• Purchase Money Mortgage (PMM): Seller financing where the seller extends credit to the buyer, taking back a mortgage or deed of trust rather than receiving full cash at closing.
• Package Mortgage: Uses both real property and personal property (appliances, furnishings) as collateral for a single loan. Common in furnished condominiums or vacation properties.
• Wraparound Mortgage: Seller creates a new, larger mortgage that "wraps around" the existing underlying mortgage. The buyer makes payments to the seller, who continues paying the original loan. The new loan amount includes the existing balance plus additional financing.
Key Terms
• Conventional Loan – non-government-backed loan
• MIP (Mortgage Insurance Premium) – FHA's version of mortgage insurance
• PMI (Private Mortgage Insurance) – conventional loan mortgage insurance
• Balloon Payment – large lump-sum payment due at end of loan term
• PMM (Purchase Money Mortgage) – seller financing arrangement
• Wraparound Mortgage – new loan encompassing an existing underlying loan
⚠️ Watch Out For
• FHA MIP vs. conventional PMI: Both protect the lender, but MIP applies to FHA loans. On FHA loans with less than 10% down, MIP lasts the entire loan term.
• VA loans have NO PMI but do charge a funding fee—these are not the same thing.
• A purchase money mortgage involves the seller as lender, not a bank. Do not confuse it with a standard loan used to purchase property.
• The wraparound mortgage may violate the due-on-sale clause of the underlying loan—be aware of this legal risk.
---
Financing Regulations & Consumer Protections
Truth in Lending Act (TILA) / Regulation Z
• Requires lenders to disclose the Annual Percentage Rate (APR), total finance charges, and other key loan terms
• Purpose: Allows borrowers to compare credit offers on an apples-to-apples basis
• Implemented through Regulation Z
• APR is always higher than the stated interest rate because it includes fees and finance charges
Real Estate Settlement Procedures Act (RESPA)
• Requires lenders to provide borrowers with disclosures about settlement/closing costs
• Prohibits kickbacks and referral fees among settlement service providers
• Regulates escrow accounts (limits on amounts lenders can require)
• Kickback: A fee, payment, or thing of value given in exchange for referring business—prohibited because it increases consumer costs without providing any service
Fair Housing Act (Title VIII – Civil Rights Act of 1968)
Prohibits discrimination in mortgage lending and all housing-related transactions based on:
• Race
• Color
• Religion
• National origin
• Sex
• Familial status
• Disability
Illegal Lending Practices
• Redlining: Refusing to make mortgage loans or offering unfavorable terms in specific geographic areas based on the racial or ethnic composition of those neighborhoods. Illegal under the Fair Housing Act and Equal Credit Opportunity Act.
• Steering: Directing buyers toward or away from neighborhoods based on protected class characteristics.
Equal Credit Opportunity Act (ECOA)
• Prohibits discrimination in credit decisions based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance
• Upon denying a credit application, lenders must:
- Notify applicants of adverse action within 30 days
- Provide specific reasons for denial or inform applicants of their right to request reasons
Key Terms
• APR (Annual Percentage Rate) – true cost of borrowing, including fees
• TILA – Truth in Lending Act; requires APR disclosure
• Regulation Z – implements TILA
• RESPA – Real Estate Settlement Procedures Act; governs settlement costs and prohibits kickbacks
• Kickback – illegal payment for referral of settlement services
• Redlining – illegal geographic discrimination in lending
• ECOA – Equal Credit Opportunity Act; prohibits credit discrimination
• Adverse Action Notice – required notification when credit is denied
⚠️ Watch Out For
• APR ≠ Interest Rate. APR is always higher because it includes fees and finance charges. Lenders disclose APR under TILA, not just the interest rate.
• TILA (RESPA) = consumer disclosure law; RESPA = settlement cost/kickback law. These are two different laws that are often confused.
• Redlining is geographic discrimination, not necessarily individual discrimination. It's still illegal even if no individual borrower is explicitly denied.
• ECOA's 30-day rule for adverse action notices is a frequently tested detail.
---
Loan Qualification & Underwriting
Loan-to-Value Ratio (LTV)
Formula: LTV = Loan Amount ÷ Property Value × 100
• Property value used is the lower of appraised value or purchase price
• Higher LTV = more risk to lender = may require PMI
• 80% LTV or below = no PMI required on conventional loans
Example: $180,000 loan on a $200,000 property = 90% LTV
Private Mortgage Insurance (PMI)
• Protects the lender (not the borrower) in case of default
• Required on conventional loans when LTV exceeds 80% (down payment less than 20%)
• Can be removed once equity reaches 20% under the Homeowners Protection Act
Discount Points
• Prepaid interest paid at closing to buy down the interest rate
• 1 point = 1% of the loan amount
• Each point typically reduces the rate by approximately 0.125%–0.25%
• Points paid to reduce the rate are tax-deductible for buyers
Example: On a $200,000 loan, 2 discount points = $4,000 paid at closing
Debt-to-Income Ratio (DTI)
Formula: DTI = Total Monthly Debt Payments ÷ Gross Monthly Income × 100
• Front-end DTI (Housing Ratio): Only housing costs (PITI) ÷ gross monthly income
• Back-end DTI (Total DTI): All monthly debt payments ÷ gross monthly income
• Most conventional loans require back-end DTI of 43% or less
• FHA allows slightly higher DTI ratios with compensating factors
Key Terms
• LTV (Loan-to-Value Ratio) – loan amount as a percentage of property value
• PMI (Private Mortgage Insurance) – lender protection on high-LTV conventional loans
• Discount Points – prepaid interest to reduce loan rate; 1 point = 1% of loan
• DTI (Debt-to-Income Ratio) – monthly debt as a percentage of gross income
• PITI – Principal, Interest, Taxes, and Insurance (total housing payment)
• Underwriting – process of evaluating borrower risk
⚠️ Watch Out For
• LTV uses the lower of appraised value or purchase price—not automatically the purchase price.
• Discount points and origination fees are different: discount points specifically buy down the rate; origination fees are lender processing charges.
• DTI uses gross income (before taxes), not net income.
• PMI protects the lender, not the borrower—a common exam trap.
---
Secondary Mortgage Market
Primary vs. Secondary Market
| Market | Who Is Involved | What Happens |
|---|---|---|
| Primary Market | Lenders and borrowers | Loans are originated |
| Secondary Market | Investors and institutions | Existing loans are bought and sold |
Key Secondary Market Players
#### Fannie Mae (FNMA – Federal National Mortgage Association)
• Government-sponsored enterprise (GSE); publicly traded but has government backing
• Purchases conforming conventional loans from lenders
• Replenishes lender funds → increases mortgage availability
#### Freddie Mac (FHLMC – Federal Home Loan Mortgage Corporation)
• Also a GSE; functions similarly to Fannie Mae
• Focuses on purchasing loans from savings institutions and banks
• Buys conforming loans and packages them as mortgage-backed securities
#### Ginnie Mae (GNMA – Government National Mortgage Association)
• Wholly government-owned (part of HUD)—unlike Fannie Mae and Freddie Mac
• Does NOT purchase loans; instead, guarantees mortgage-backed securities (MBS)
• Backs securities composed of government-insured loans only: FHA, VA, and USDA loans
Conforming Loans
• Meet the purchasing guidelines set by Fannie Mae and Freddie Mac
• Must comply with loan limits (set annually) and underwriting standards
• Eligible for sale on the secondary market
• Loans exceeding the limit are called jumbo loans (non-conforming)
Key Terms
• Primary Market – where loans are originated between lenders and borrowers
• Secondary Market – where existing loans are bought and sold
• Fannie Mae (FNMA) – GSE; buys conforming conventional loans
• Freddie Mac (FHLMC) – GSE; buys conforming loans from depository institutions
• Ginnie Mae (GNMA) – government agency; guarantees MBS backed by FHA/VA/USDA loans
• Conforming Loan – meets Fannie Mae/Freddie Mac guidelines
• Jumbo Loan – exceeds conforming loan limits; non-conforming
• MBS (Mortgage-Backed Securities) – investment securities backed by pools of mortgages
⚠️ Watch Out For
• Ginnie Mae ≠ Fannie Mae or Freddie Mac. Ginnie Mae is a true government agency and does not buy loans—it only guarantees securities backed by government loans.
• Fannie Mae and Freddie Mac deal with conforming conventional loans, not government-backed FHA/VA loans (that's Ginnie Mae's territory).
• The secondary market does not involve new borrowers—it is about the buying and selling of existing loans between institutions.
• Conforming loan limits change annually—the exam tests your understanding of the concept, not a specific dollar amount.
---
Quick Review Checklist
Use this checklist to confirm your mastery before exam day:
Mortgage Instruments & Documents
• [ ] Explain the three-party structure of a deed of trust (trustor, beneficiary, trustee)
• [ ] Distinguish the promissory note from the deed of trust
• [ ] Define acceleration clause, due-on-sale clause, and subordination clause
• [ ] Define deficiency judgment and when it occurs
Loan Types
• [ ] Identify FHA (3.5% down, MIP), VA (0% down, no PMI, funding fee), and conventional loan features
• [ ] Describe balloon mortgages and the risk they pose
• [ ] Explain purchase money mortgages (seller financing)
• [ ] Distinguish package mortgages from wraparound mortgages
Financing Regulations
• [ ] State the purpose of TILA/Regulation Z (APR disclosure)
• [ ] State the purpose of RESPA (settlement disclosures, no kickbacks)
• [ ] Identify the seven protected classes under the Fair Housing Act
• [ ] Define redlining and why it is illegal
• [ ] Recall ECOA's 30-day adverse action notice requirement
Loan Qualification
• [ ] Calculate LTV using loan amount ÷ property value × 100
• [ ] Know that PMI is required on conventional