Study guide
A transaction is not complete until financing is arranged and the numbers are settled at the closing table, so this chapter covers the major loan types buyers use, the federal rules that govern how lenders disclose credit terms, and the calculations every licensee must be able to perform quickly and correctly. Worked examples use invented names and numbers to walk through each formula step by step.
Loan Types and Qualification Basics
A conventional loan is any mortgage not insured or guaranteed by a federal agency, typically underwritten to standards set by government-sponsored entities that purchase loans on the secondary market. Conventional loans usually require a stronger credit profile and, when the down payment is below 20 percent of value, the lender requires private mortgage insurance, or PMI, which protects the lender, not the borrower, against default. An FHA loan is insured by the Federal Housing Administration and allows a lower down payment and more flexible credit standards than most conventional loans, but requires mortgage insurance premiums, called MIP, for some portion or the full life of the loan depending on the down payment and term. A VA loan is guaranteed by the Department of Veterans Affairs for eligible veterans, active-duty service members, and certain surviving spouses, and typically requires no down payment and no ongoing mortgage insurance, though it may carry a funding fee. A USDA loan, backed by the Department of Agriculture, supports homebuyers in eligible rural areas and moderate-income borrowers, generally with no down payment requirement. Loan-to-value ratio, or LTV, compares the loan amount to the lower of the sale price or appraised value, and it is central to underwriting: a lower LTV means the borrower has more equity at stake and typically qualifies for better terms. Buyer qualification also considers debt-to-income ratios, comparing monthly housing and total debt obligations to gross monthly income, along with credit history, employment stability, and available reserves.
Federal Financing Regulation and the Closing Process
Several federal laws shape how residential financing is disclosed and administered, though enforcement details and specific dollar thresholds change periodically, so candidates should verify current figures against current regulatory guidance. The Truth in Lending Act, implemented through Regulation Z, requires lenders to disclose the true cost of credit, including the annual percentage rate, or APR, which reflects the interest rate plus certain finance charges, giving borrowers a clearer basis for comparing loan offers. TRID, short for the TILA-RESPA Integrated Disclosure rule, combined and streamlined federally required disclosures into two primary forms: the Loan Estimate, provided early in the process, and the Closing Disclosure, provided shortly before closing, giving the borrower a defined waiting period to review final terms before signing. The Real Estate Settlement Procedures Act, or RESPA, prohibits kickbacks and unearned referral fees between settlement service providers and requires disclosure of business relationships that could influence a consumer's choice of provider. The Equal Credit Opportunity Act, or ECOA, prohibits lenders from discriminating in any aspect of a credit transaction based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance income. At closing, sometimes called settlement, the buyer and seller finalize the transaction: the buyer signs loan documents and pays remaining funds due, the seller signs the deed and satisfies any existing liens, and a neutral settlement agent, which may be an attorney, escrow company, or title company depending on regional practice, disburses funds and records the new deed and mortgage. A settlement statement itemizes every credit and debit for both parties, including prorated items, so both sides can see exactly how the final cash figures were reached.
Commission and Net-to-Seller Calculations
Commission problems generally start with the commission formula: sale price multiplied by commission rate equals total commission. Consider a seller named Owen who sells his home for 340,000 dollars under a listing agreement with a 6 percent commission. Total commission equals 340,000 times 0.06, or 20,400 dollars. If the listing broker and the buyer's broker split that commission evenly, each brokerage receives 10,200 dollars, and if an individual agent then keeps 60 percent of the amount her brokerage receives, her personal share is 10,200 times 0.60, or 6,120 dollars. Net-to-seller problems work backward from a target amount the seller wants in hand. Suppose a seller named Farrah wants to net exactly 250,000 dollars after paying a 5 percent commission and no other costs. Because the commission is a percentage of the final sale price rather than of the net figure, the sale price is found by dividing the desired net by one minus the commission rate: 250,000 divided by (1 minus 0.05), which is 250,000 divided by 0.95, giving a required sale price of approximately 263,158 dollars. Checking the math, 263,158 times 0.05 is about 13,158 dollars in commission, and 263,158 minus 13,158 returns approximately 250,000 dollars, confirming the answer. This division method, dividing the desired net by one minus the percentage taken out, is the general technique for any net-to-seller or net-listing calculation, and it is worth memorizing precisely because dividing by the commission rate itself, rather than by one minus the rate, is the most common error candidates make under time pressure.
Proration at Closing
Proration divides an ongoing expense or income item between buyer and seller based on how much of the relevant period each party actually owned the property. Suppose annual property taxes of 3,650 dollars are paid in arrears, meaning owed for the past year, and a sale closes on April 1, with the seller responsible for every day up to and including closing day, a common convention that can vary by contract or local custom. Using a 365-day year for simplicity, daily taxes equal 3,650 divided by 365, or 10 dollars per day. If closing falls on day 91 of the calendar year, meaning January 31 plus February 28 plus March 31 plus April 1, the seller owes 91 times 10 dollars, or 910 dollars, credited to the buyer at closing since the buyer will ultimately pay the full year's bill. Rent proration works the same way. Suppose a rental property with monthly rent of 1,800 dollars closes on June 11, and the buyer is entitled to rent from the closing day forward. Daily rent equals 1,800 divided by 30, or 60 dollars per day, assuming a 30-day month convention. The buyer is entitled to 20 days of June, from the 11th through the 30th, so the seller credits the buyer 20 times 60 dollars, or 1,200 dollars, out of rent the seller already collected from the tenant. HOA dues prorate identically: a monthly due of 300 dollars produces a daily rate of 10 dollars, and whichever party paid the association in advance receives a credit at closing for the days after their ownership ends. The core discipline is always the same three steps: find the total period the charge covers, divide to find a daily or per-unit rate, then multiply by the number of days that belong to the other party.
LTV, Area Conversions, PITI, and Return on Investment
Loan-to-value ratio equals the loan amount divided by the lesser of purchase price or appraised value. Suppose a buyer named Talia is purchasing a home appraised at 400,000 dollars for a contract price of 395,000 dollars, and her lender approves a loan of 316,000 dollars. Because 395,000 is lower than the appraisal, LTV is based on 395,000: 316,000 divided by 395,000 equals 0.80, or an 80 percent LTV, which is the common threshold at or below which PMI is typically not required on a conventional loan. Area problems commonly convert between square feet and acres, since one acre equals 43,560 square feet. A rectangular lot measuring 150 feet by 290 feet contains 150 times 290, or 43,500 square feet, which is 43,500 divided by 43,560, or approximately 0.999 acres, essentially one acre. PITI stands for the four components of a typical monthly mortgage payment: principal, the portion reducing the loan balance; interest, the cost of borrowing; taxes, the prorated monthly share of annual property taxes; and insurance, the prorated monthly share of the homeowner's insurance premium, often collected through an escrow account alongside any required mortgage insurance. Appreciation problems ask for a percentage increase in value: if a property purchased for 280,000 dollars is later worth 308,000 dollars, appreciation equals the increase, 28,000 dollars, divided by the original value, 280,000 dollars, equal to 0.10, or 10 percent appreciation. Return on investment, or ROI, follows the same logic applied to cash invested rather than property value: if an investor named Rashid puts 40,000 dollars in cash into a rental property that generates 3,200 dollars in net income over a year, ROI equals 3,200 divided by 40,000, or 0.08, meaning an 8 percent annual return on his invested cash.
Key terms
- Private mortgage insurance (PMI)
- — Insurance required on most conventional loans with less than 20 percent down, protecting the lender rather than the borrower against default.
- Mortgage insurance premium (MIP)
- — The insurance premium charged on FHA-insured loans, required for some or all of the loan term depending on down payment and term.
- Loan-to-value ratio (LTV)
- — The loan amount divided by the lesser of the purchase price or appraised value, expressed as a percentage.
- Truth in Lending Act / Regulation Z
- — Federal law requiring lenders to disclose the true cost of credit, including the annual percentage rate.
- TRID (TILA-RESPA Integrated Disclosure)
- — The rule combining required federal mortgage disclosures into the Loan Estimate and Closing Disclosure forms.
- RESPA
- — Federal law prohibiting kickbacks and unearned fees between settlement service providers and requiring disclosure of referral relationships.
- ECOA
- — Federal law prohibiting credit discrimination based on race, color, religion, national origin, sex, marital status, age, or public assistance income.
- Proration
- — Dividing an ongoing expense or income item, such as taxes or rent, between buyer and seller based on each party's period of ownership.
- PITI
- — The four components of a typical monthly mortgage payment: principal, interest, taxes, and insurance.
- Acre
- — A unit of land area equal to 43,560 square feet, used in area and conversion calculations.
- Return on investment (ROI)
- — Net income or gain divided by the amount of cash invested, expressed as a percentage annual return.
Exam tips
- For net-to-seller problems, always divide the desired net amount by one minus the commission rate; dividing by the rate itself is the single most common calculation error on this topic.
- For proration, work out the daily rate first by dividing the total charge by the number of days it covers, then multiply by the number of days belonging to the party being charged or credited.
- LTV always uses the lesser of appraised value or purchase price in the denominator when the two differ; using the higher figure by mistake is a frequent trap.
- Memorize 43,560 square feet per acre cold, since acreage and square footage conversions appear across multiple math question formats.
- Keep PITI in order — principal, interest, taxes, insurance — and remember taxes and insurance are typically collected monthly through escrow even though the underlying bills are usually annual.