Real Estate Financing
Almost every California sale involves borrowed money, so financing is both a large exam topic and a practical necessity. This chapter explains the security instrument California actually uses — the deed of trust, not the mortgage — and the fast nonjudicial foreclosure that comes with it, along with loan types, loan structures, the arithmetic of points and loan-to-value ratios, and the federal and state laws that govern lending disclosure. Focus on what is distinctly Californian: three-party deeds of trust, trustee's sales, and the state's limits on prepayment penalties and usury.
Trust Deeds and Security Instruments
When a borrower finances real estate, two documents are created: a promissory note, which is the borrower's personal promise to repay the debt, and a security instrument, which pledges the property as collateral. In most states that instrument is a mortgage, but California overwhelmingly uses the deed of trust. Knowing the difference — and the three parties to a deed of trust — is essential. A California deed of trust involves three parties. The trustor is the borrower, who conveys title. The beneficiary is the lender, who benefits from the security and holds the note. The trustee is a neutral third party (often a title or trust company) who holds "bare" or naked legal title as security, with the power to reconvey the property to the borrower when the loan is paid or to sell it if the borrower defaults. A two-party mortgage, by contrast, has only a mortgagor (borrower) and mortgagee (lender). This three-party structure is what enables California's fast foreclosure. Because the deed of trust contains a power-of-sale clause, the lender does not have to sue to foreclose. Instead, upon default the beneficiary instructs the trustee to conduct a nonjudicial trustee's sale after giving the statutory notices — a recorded Notice of Default followed, after a waiting period, by a Notice of Trustee's Sale — and observing the required timelines. Verify the current statutory periods, which the legislature adjusts. A nonjudicial sale is faster and cheaper than a court foreclosure but bars the lender from pursuing a deficiency judgment. Security instruments commonly contain protective clauses. An acceleration clause lets the lender declare the entire unpaid balance immediately due upon default. A due-on-sale (alienation) clause lets the lender call the loan due if the property is sold or transferred, preventing an unqualified buyer from simply taking over the loan. When the debt is satisfied, the trustee records a deed of reconveyance to clear the lien from title.
Loan Types and Programs
Loans are commonly grouped by who insures or guarantees them and by the borrower they serve. The exam expects you to distinguish government-backed programs from conventional loans and to know the special California veteran program. An FHA loan is insured by the Federal Housing Administration and originated by an FHA-approved lender. FHA does not make loans; it insures the lender against loss, which allows lower down payments and more flexible qualifying. Borrowers pay a mortgage insurance premium for this protection. A VA loan is guaranteed by the U.S. Department of Veterans Affairs for eligible veterans and service members; the guarantee often permits a zero-down-payment purchase up to program limits, with no monthly mortgage insurance. FHA and VA loans typically carry limits and property standards; verify current figures with the agencies. California offers the Cal-Vet program through the state Department of Veterans Affairs. Cal-Vet is structurally distinct: the state actually buys the property and then resells it to the eligible veteran, usually under a contract of sale (a land contract) in which the state holds legal title until the veteran completes payments. This differs from FHA and VA, where a private lender makes the loan. A conventional loan is any loan that is neither insured by FHA nor guaranteed by VA — in other words, not backed by a government agency. Conventional loans are made by banks, credit unions, and mortgage companies and are often sold to Fannie Mae or Freddie Mac in the secondary market. When the borrower's down payment is less than 20 percent (a loan-to-value ratio above 80 percent), the lender typically requires private mortgage insurance (PMI) to cover the added risk; PMI can generally be removed once sufficient equity is reached. Matching a borrower's profile — veteran, low down payment, strong credit — to the right program is a core competency.
Loan Terms and Structure
Beyond who backs a loan, the exam tests how a loan is structured — how the payments are arranged and how the interest rate behaves. These structures determine the borrower's monthly obligation and long-term risk. A fully amortized loan retires the entire debt through equal periodic payments over the term. Each payment covers the interest due plus a portion of principal; early payments are mostly interest, and later payments are mostly principal, until the balance reaches zero at maturity. This is the standard 30-year home loan. A partially amortized loan makes regular payments but leaves a balance — a balloon payment — due in a large lump sum at maturity. An interest-only or straight (term) loan pays only interest during the term, with the full principal due at the end. Recognizing which structure a question describes tells you whether the balance shrinks to zero or a balloon remains. An adjustable-rate mortgage (ARM) has an interest rate that changes over time. The rate equals a fixed margin (the lender's markup) plus a fluctuating index (a published benchmark rate). As the index moves, so does the borrower's rate and payment. To protect borrowers, ARMs include caps — periodic caps that limit how much the rate can change at each adjustment and lifetime caps that limit the total change over the loan's life. A fixed-rate loan, by contrast, keeps the same rate and payment throughout. A prepayment penalty is a charge the lender imposes when the borrower pays the loan off early, compensating the lender for lost interest. California law limits prepayment penalties on many owner-occupied residential loans, both in amount and in how long they may apply; verify the current restrictions, which are borrower-protective. Related features include a lock-in clause (barring early payoff for a period), a subordination clause (making one loan's priority junior to another), and a defeasance clause (releasing the security when the debt is paid). Understanding these terms lets a salesperson explain a loan's real cost and flexibility to a buyer.
Points, LTV, and Loan Math
Financing questions frequently require arithmetic, and the good news is that the formulas are simple and repeat. Master three: points, loan-to-value, and simple interest. A discount point is a fee equal to one percent of the loan amount, paid up front as prepaid interest to "buy down" the interest rate. The crucial detail, and a favorite trap, is that points are always calculated on the loan amount, not the purchase price. If a buyer borrows $200,000 and pays two points, the charge is 2% of $200,000 = $4,000. Origination fees are quoted the same way, as a percentage of the loan. Never multiply points by the sale price unless the loan happens to equal the price. The loan-to-value ratio (LTV) equals the loan amount divided by the property's value or price, whichever is lower, expressed as a percentage. If a home is worth $400,000 and the loan is $320,000, the LTV is 320,000 ÷ 400,000 = 80%. Lenders cap LTV to control risk; a higher LTV means a smaller down payment and greater lender exposure, which is why loans above 80% LTV usually require mortgage insurance. To find a down payment, subtract the loan from the price: a 90% LTV on a $400,000 home means a $360,000 loan and a $40,000 (10%) down payment. Simple annual interest equals the outstanding principal balance times the annual interest rate: Interest = Principal × Rate. For a monthly figure, divide the annual interest by 12. On a $300,000 balance at 6%, annual interest is 300,000 × 0.06 = $18,000, and one month's interest is 18,000 ÷ 12 = $1,500. You can rearrange the same formula to solve for any missing variable — rate equals interest divided by principal, and principal equals interest divided by rate. Because California often uses a 360-day banker's year for certain prorations, read each problem carefully to see which day-count it assumes.
Federal and State Lending Law
Consumer-protection laws regulate how loans are disclosed and marketed. The exam tests the purpose of each major law rather than fine mechanical detail, but you must match each law to what it does. The Real Estate Settlement Procedures Act (RESPA) is a federal law covering most federally related mortgage loans on one-to-four residential units. It requires lenders to disclose settlement (closing) costs so borrowers can shop and compare, and it prohibits kickbacks, referral fees, and unearned fees among settlement-service providers. A licensee may not accept a payment for merely referring a buyer to a lender or title company. The Truth in Lending Act (TILA), implemented by Regulation Z, requires lenders to disclose the true cost of credit — most importantly the annual percentage rate (APR), which folds finance charges into a single comparable rate, and the total finance charge. TILA also governs certain advertising: if an ad states one credit term (such as a down payment or monthly payment), it must disclose the other required terms so consumers are not misled. Regulation Z gives borrowers a three-day right of rescission on certain refinances of a principal residence (not on a purchase-money loan). Today, RESPA and TILA disclosures for most closed-end mortgages are combined into the TRID disclosures — the Loan Estimate delivered early and the Closing Disclosure delivered before closing — administered by the Consumer Financial Protection Bureau. Verify current TRID timing rules, which are precise. At the state level, California's usury law caps the interest rate that may be charged on certain private, non-exempt loans. The constitution sets the ceilings, but the exemptions are what matter in practice: loans made or arranged by a licensed real estate broker, and loans by most institutional lenders such as banks and savings institutions, are exempt from the usury limits. Additional laws — the Equal Credit Opportunity Act barring discrimination in lending, and the Home Mortgage Disclosure Act — round out the framework. Knowing which law addresses disclosure, which addresses kickbacks, and which addresses rate caps lets you answer this family of questions quickly.
Last updated: September 2026
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