Study guide
The broker exam tests financing knowledge more heavily and more numerically than the salesperson exam, because brokers are expected to review closing statements, verify agent-prepared net sheets, and explain financing structures to clients. This chapter covers loan terminology, underwriting, the major loan types, the core federal disclosure and lending laws, and the calculations most frequently tested, including proration, net proceeds, and rate-of-return math. Work through every formula by hand at least once; recognizing the concept is not the same as being able to compute it under time pressure.
Loan Terminology and the Mechanics of Underwriting
Loan-to-value ratio (LTV) expresses the loan amount as a percentage of the property's appraised value or purchase price, whichever is lower: a $240,000 loan on a $300,000 home is an 80% LTV. Lenders generally require private mortgage insurance (PMI) on conventional loans when LTV exceeds 80%, protecting the lender, not the borrower, against default; PMI can typically be cancelled once the loan balance is paid down to 80% of the original value and must be automatically terminated at 78% under the Homeowners Protection Act, absent delinquency. PITI stands for Principal, Interest, Taxes, and Insurance, the four components of a typical monthly mortgage payment when taxes and insurance are escrowed by the lender. A discount point equals 1% of the loan amount, paid at closing to buy down the interest rate; an origination fee, also usually expressed in points, compensates the lender for processing the loan and does not reduce the rate. Amortization is the gradual repayment of a loan through scheduled payments that cover accruing interest and reduce principal over time; in a fully amortized loan, the final payment brings the balance to zero, while a partially amortized (balloon) loan requires a large lump-sum payment at maturity because scheduled payments do not fully retire the debt. Underwriting is the lender's process of evaluating a borrower's creditworthiness and the property's value to decide whether to approve a loan, weighing credit score and history, debt-to-income ratio (comparing monthly obligations to gross monthly income), employment and income stability, and the appraised value as collateral. Two common ratios are the housing ratio (PITI divided by gross monthly income, often capped around 28%) and the total debt ratio (all monthly debts including PITI divided by gross monthly income, often capped around 36 to 43%, depending on loan program).
Notes, Security Instruments, and Loan Products
The promissory note is the borrower's personal promise to repay the debt, stating the amount, interest rate, repayment terms, and remedies for default; it is the evidence of the debt itself. The mortgage or deed of trust is the security instrument that pledges the real property as collateral for that promise; in a mortgage state, two parties are involved (borrower-mortgagor and lender-mortgagee) and foreclosure is typically judicial; in a deed-of-trust state, three parties are involved (borrower-trustor, lender-beneficiary, and a neutral trustee who holds legal title and can conduct a nonjudicial foreclosure sale under a power-of-sale clause). Key clauses include the acceleration clause, allowing the lender to demand the full balance immediately upon default; the due-on-sale clause, requiring full repayment if the property is sold or transferred; the defeasance clause, requiring the lender to release the lien once the debt is paid in full; and the prepayment clause, which may impose a penalty for paying off the loan early. A conventional loan is not insured or guaranteed by a government agency and typically requires PMI above 80% LTV. An adjustable-rate mortgage (ARM) has an interest rate that changes periodically based on a financial index plus a margin, usually with an initial fixed period, periodic and lifetime rate caps, and an adjustment interval. FHA loans are insured by the Federal Housing Administration, feature lower down payment requirements, and require mortgage insurance premiums (MIP) rather than PMI. VA loans are guaranteed (not insured) by the Department of Veterans Affairs for eligible service members and veterans, typically requiring no down payment and no monthly mortgage insurance. USDA loans support low-to-moderate-income buyers in eligible rural areas with reduced or no down payment. Owner (seller) financing occurs when the seller extends credit directly to the buyer, often secured by a purchase-money mortgage or a land contract (contract for deed), where the seller retains legal title until the buyer completes payments. A reverse mortgage allows homeowners, typically age 62 or older, to convert home equity into loan proceeds without monthly repayment, with the loan becoming due upon sale, death, or the borrower's move from the property. A home equity line of credit (HELOC) is a revolving credit line secured by a second lien against the home's equity. Construction, rehabilitation, and bridge loans are short-term products: construction loans fund building in draws tied to completion stages; rehab loans (such as government-backed renovation programs) finance purchase plus repair costs in a single loan; bridge loans provide short-term financing to help a buyer close on a new property before their existing property sells.
Federal Lending and Disclosure Law
The Real Estate Settlement Procedures Act (RESPA) governs federally related mortgage loans on one-to-four-family residential property, prohibiting kickbacks and unearned referral fees between settlement service providers and requiring disclosure of any affiliated business relationships. TRID, the TILA-RESPA Integrated Disclosure rule, consolidated RESPA and Truth-in-Lending disclosures into two forms: the Loan Estimate, provided within three business days of application, and the Closing Disclosure, provided at least three business days before consummation (closing), giving borrowers time to compare final terms to what was originally estimated. The Truth-in-Lending Act, implemented through Regulation Z, requires lenders to disclose the true cost of credit, most notably the Annual Percentage Rate (APR), which incorporates interest plus certain fees and points, making it a more complete cost measure than the stated note rate alone; Reg Z also governs advertising, requiring that any advertisement listing specific credit terms (a 'trigger term' like a down payment or monthly payment) include a full set of required disclosures. The Equal Credit Opportunity Act (ECOA) prohibits lenders from discriminating in any aspect of a credit transaction based on race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), receipt of public assistance income, or the good-faith exercise of rights under the Consumer Credit Protection Act; ECOA also gives applicants the right to know the specific reasons for a credit denial. Brokers should recognize that these laws regulate the lending and settlement process itself, layered on top of, and separate from, the Fair Housing Act's broader prohibition on discrimination in housing generally.
Closing and Proration Calculations
Seller net proceeds is calculated by starting with the agreed sale price, then subtracting the existing loan payoff, real estate commission, seller-paid closing costs, prorated items owed by the seller, and any transfer or recordation fees the seller customarily pays; the remainder is what the seller nets in hand. Buyer funds needed at closing typically equals the down payment plus buyer-paid closing costs plus prepaid items (initial escrow deposits for taxes and insurance) plus or minus proration adjustments, minus any earnest money already deposited and any seller credits. Prorations divide ongoing expenses, most commonly property taxes, HOA dues, and rents, between buyer and seller based on the number of days each party owns the property within a billing period; if taxes are paid in arrears (owed after the period they cover), the seller owes the buyer a credit for their share of unpaid taxes up to closing, and if paid in advance, the buyer owes the seller a credit for the prepaid period beyond closing. A basic 365-day or 360-day proration divides the annual expense by the day count for a daily rate, then multiplies by the number of days applicable to each party; some closings use 'statutory' or banker's months of 30 days each, so always confirm which method a problem intends. Transfer fees (often called transfer taxes or recording fees) are charged by some state or local governments on the transfer of title and are frequently negotiable between buyer and seller by custom or contract.
Investment and Rate Calculations
Equity is the difference between a property's current market value and the outstanding balance of any liens against it; equity grows through principal paydown, appreciation, or both. The capitalization rate (cap rate) equals net operating income divided by property value or sale price, expressed as a percentage; rearranged, value equals NOI divided by cap rate, and NOI equals value multiplied by cap rate. Cash-on-cash return, a simpler investor metric, divides annual pre-tax cash flow by the actual cash invested (the down payment plus closing costs), rather than the full property value. To find loan-to-value ratio, divide the loan amount by the lesser of appraised value or sale price. To calculate the cost of discount points, multiply the number of points by 1% of the loan amount; two points on a $200,000 loan costs $4,000. To calculate a monthly PITI estimate, add the monthly principal-and-interest payment (from an amortization table or formula) to one-twelfth of the annual property tax bill and one-twelfth of the annual homeowner's insurance premium. Broker exam math questions often combine several steps: for example, finding a seller's net proceeds after paying off a mortgage, a 6% commission, and a prorated tax credit to the buyer, all within one problem. The reliable method is to build each number in a simple vertical list, sale price at the top, then subtract each cost line by line, keeping a running subtotal, rather than trying to combine multiple formulas mentally.
Key terms
- Loan-to-value ratio (LTV)
- — The loan amount expressed as a percentage of the property's appraised value or sale price, whichever is lower.
- Private mortgage insurance (PMI)
- — Insurance required on most conventional loans above 80% LTV that protects the lender, not the borrower, against default.
- PITI
- — The four components of a typical monthly mortgage payment: principal, interest, taxes, and insurance.
- Discount point
- — A fee equal to 1% of the loan amount paid at closing to reduce the loan's interest rate.
- Promissory note
- — The borrower's personal written promise to repay a debt under stated terms; the evidence of the loan obligation.
- Deed of trust
- — A three-party security instrument (borrower, lender, and trustee) that allows nonjudicial foreclosure under a power-of-sale clause.
- Annual Percentage Rate (APR)
- — The true cost of credit expressed as a yearly rate, including interest plus certain fees, as required under Regulation Z.
- Loan Estimate
- — The TRID disclosure a lender must provide within three business days of a completed loan application, summarizing estimated loan terms and costs.
- Closing Disclosure
- — The TRID disclosure summarizing final loan terms and costs, required at least three business days before closing.
- Proration
- — The division of an ongoing expense, such as property tax, between buyer and seller based on each party's period of ownership.
- Capitalization rate
- — Net operating income divided by property value, used to estimate value or expected return on income-producing property.
- Equity
- — The difference between a property's current market value and the total balance of liens against it.
Exam tips
- Turn every math word problem into a vertical list of line items rather than a single equation; broker exams reward orderly subtraction over mental shortcuts.
- Remember the direction of the cap rate formula: Value = NOI ÷ Cap Rate. If the question gives value and NOI and asks for the rate, divide NOI by value instead.
- APR is not the same as the note rate — APR folds in points and certain fees, so it is always the more complete (and usually higher) number for closed-end loans.
- TRID timing is a favorite trick question: Loan Estimate = 3 business days after application; Closing Disclosure = at least 3 business days before closing.
- For proration problems, first determine whether the expense is paid in arrears or in advance — that single fact determines whether the seller owes the buyer a credit or the reverse.