Financing: Practice Questions & Explanations

A mortgage and a deed of trust serve the same economic function — securing a loan with real property as collateral — but use different legal structures. A mortgage is a two-party agreement: the borrower (mortgagor) pledges the property to the lender (mortgagee) as security. If default occurs, the lender must go through judicial foreclosure (a court proceeding), which can take months to years. A deed of trust adds a third party, a trustee (often a title company), who holds title to the property as security on behalf of the lender (beneficiary). If the borrower (trustor) defaults, the trustee can conduct a non-judicial foreclosure outside court, typically a faster process. Which is used depends on state law: some states use mortgages, some use deeds of trust, and some allow both.

PITI stands for Principal, Interest, Taxes, and Insurance — the four standard components of a typical mortgage payment. Principal repays the loan balance; interest is the cost of borrowing; taxes are property taxes collected by the lender and held in escrow to pay the local government; insurance is homeowner's insurance (and sometimes private mortgage insurance, PMI, when the down payment was below 20%). Lenders use PITI as a stand-in for the borrower's total housing cost when calculating debt-to-income ratios for qualification. Some borrowers pay taxes and insurance themselves rather than escrowing through the lender; that arrangement is allowed when the down payment is large enough.

RESPA (Real Estate Settlement Procedures Act, 1974) is a federal consumer protection law that regulates residential mortgage transactions. Key requirements: (1) lenders must provide a Loan Estimate within 3 business days of application, summarizing loan terms and estimated closing costs; (2) lenders must provide a Closing Disclosure at least 3 business days before closing, detailing the actual final terms; (3) kickbacks for referrals between settlement service providers are prohibited; (4) escrow accounts for taxes and insurance are regulated. RESPA is enforced by the Consumer Financial Protection Bureau (CFPB). Violations can result in significant penalties. The 3-day disclosure rule is intended to give borrowers time to review final terms before they are committed.

LOAN-TO-VALUE (LTV) = loan amount ÷ property value (appraised or purchase price, whichever is lower). Example: $280,000 loan on a $350,000 property = 80% LTV. Why it matters: RISK ASSESSMENT: Lenders view high LTV as higher risk (less equity cushion); PRIVATE MORTGAGE INSURANCE (PMI): Conventional loans with LTV above 80% require PMI — additional monthly insurance protecting the lender if the borrower defaults; PMI can be cancelled when LTV reaches 80% (by law at 78%); DOWN PAYMENT RELATIONSHIP: 20% down payment = 80% LTV = no PMI; FHA loans allow LTV up to 96.5% (3.5% down) but require MIP (mortgage insurance premium) for the loan's life regardless of LTV; VA loans allow 100% LTV (zero down) with no PMI.

MORTGAGOR vs MORTGAGEE: MORTGAGOR = the BORROWER — they 'give' (grant) the mortgage to the lender as security for the loan; the suffix '-or' is the one giving; MORTGAGEE = the LENDER — they 'receive' the mortgage; the suffix '-ee' is the one receiving; MEMORY AID: The borrOWER OWES; the mortgagOR gives (and owes); the mortgagEE receives (the bank); SIMILAR PAIRS: Lessor (landlord, gives the lease) / Lessee (tenant, receives); Grantor (gives the deed) / Grantee (receives); Optionor (gives the option) / Optionee (receives); Vendor (seller) / Vendee (buyer); the '-or gives, -ee receives' pattern applies throughout real estate; this terminology is fundamental and frequently tested on the national exam; in a mortgage transaction, the borrower (mortgagor) pledges the property as security to the lender (mortgagee).

AMORTIZATION: The process of gradually paying off a loan through scheduled regular payments that include both PRINCIPAL and INTEREST, structured so the loan balance reaches ZERO by the end of the term. FULLY AMORTIZED LOAN: Each payment covers all the interest due plus some principal; early payments are mostly interest, later payments mostly principal (the ratio shifts over time); the balance is fully paid at maturity; AMORTIZATION SCHEDULE: Shows each payment's split between principal and interest and the declining balance; CONTRAST: INTEREST-ONLY loan (payments cover only interest, principal due at end); BALLOON loan (smaller payments with a large lump sum due at the end — not fully amortized); NEGATIVE AMORTIZATION (payments don't cover interest, balance grows); EQUITY builds as principal is paid down and (potentially) the property appreciates; amortization is a fundamental financing concept on the national exam — understanding that early payments are interest-heavy and the loan self-liquidates over the term is key.

TRUTH IN LENDING ACT (TILA): A federal consumer protection law requiring lenders to DISCLOSE the true cost of credit so borrowers can make informed decisions and compare loans. KEY DISCLOSURE — APR (Annual Percentage Rate): Reflects the interest rate PLUS certain loan costs/fees (origination fees, points, mortgage insurance), expressed as a yearly rate; the APR is usually HIGHER than the note rate because it includes those costs; it lets borrowers compare the true cost of different loan offers on a standardized basis; OTHER TILA DISCLOSURES: Finance charge, amount financed, total of payments, payment schedule; REGULATION Z implements TILA; TRID (TILA-RESPA Integrated Disclosure): Combined TILA and RESPA disclosures into the Loan Estimate (given within 3 days of application) and Closing Disclosure (given at least 3 days before closing); RIGHT OF RESCISSION: For certain refinances of a primary residence, TILA gives a 3-day right to cancel; PURPOSE: Consumer protection through transparency; APR enables apples-to-apples loan comparison; understanding TILA, APR, and the related disclosures is important financing/consumer-protection knowledge tested on the national exam.

A financed purchase involves two key instruments. The promissory note is the borrower's written promise to repay the loan — it states the amount, interest rate, payment terms, and is the evidence of the debt. The mortgage (or, in many states, a deed of trust) is the security instrument: it pledges the real property as collateral and gives the lender the right to foreclose if the borrower defaults. The note creates the personal obligation; the mortgage attaches that obligation to the property. In deed-of-trust states a third party (the trustee) holds title until the loan is repaid. Distinguishing the debt instrument from the security instrument is core financing content.

The Truth in Lending Act (TILA), implemented through Regulation Z, requires lenders to disclose the cost of consumer credit in a uniform way so borrowers can compare loans. Key disclosures include the annual percentage rate (APR), the finance charge, the amount financed, and the total of payments. TILA also governs certain advertising of credit terms — if an ad states one specific term such as the down payment or a rate, it can trigger the requirement to disclose other terms. TILA is separate from RESPA (which governs settlement-cost disclosures and prohibits kickbacks) and from the Fair Housing Act (which bars discrimination). Consumer-protection financing laws appear regularly on the national portion.