Finance, Mortgages & Loan Types

The promissory note is the primary evidence of the debt obligation; the security instrument (deed of trust or mortgage) secures the note against real property. The note and the security instrument are separate documents with different functions.

The promissory note states the borrower's personal promise to pay, the principal, interest, maturity, and other repayment terms. The deed of trust (or mortgage in some states) is a separate security instrument that places a lien on identified property to secure that debt. A valid note can exist without this particular parcel securing it; conversely, the lien is tied to the secured obligation and does not replace the payment promise.

In California, a deed of trust commonly names a trustor (borrower), beneficiary (lender), and trustee. The trustee holds security title and may exercise a power of sale only when the instrument and applicable foreclosure law authorize it and required procedures are followed. A security instrument is therefore not simply another name for the note, nor does a trustee's role make the trustee the lender.

A deed of trust involves a trustor (borrower), beneficiary (lender), and trustee who holds nominal title for security purposes. The trustee's power of sale enables non-judicial foreclosure under certain conditions.

The trustor conveys a security interest through the deed of trust, the beneficiary is the lender or other secured creditor, and the trustee is the named neutral holder of the power described in the instrument. This is a security arrangement, not an ordinary trust in which the trustee has beneficial ownership. The beneficiary receives the economic benefit of the lien; the trustee's authority is limited by the instrument and law.

A nonjudicial sale is not automatic merely because a payment is late. The loan documents must contain a power of sale and statutory notices, waiting periods, and other foreclosure steps must be satisfied. A trustee's deed follows a completed sale; it is not the deed that originally conveys the borrower's ownership to the lender at loan origination.

Simple interest is calculated on principal only. I = P × R × T. Many loan questions test whether you understand this basic formula and can apply it correctly.

Simple interest is charged on the original principal rather than on accumulated interest. The standard formula is I = P × R × T, with the rate written as a decimal and time expressed in the matching period. If annual rate is 6% and time is six months, use 0.06 and 0.5 years; if a question specifies a day-count convention, use that convention instead.

This formula estimates interest for the stated interval; it does not by itself calculate a periodic mortgage payment or reflect amortization. On an amortizing loan, each payment changes the outstanding principal, so later interest is calculated on the reduced balance. Identify whether the question asks for interest accrued on a fixed principal, total interest over a schedule, or a payment.

Loan-to-value ratio (LTV) is the loan amount divided by the property value or purchase price. Higher LTV generally means more risk for the lender and can trigger mortgage insurance requirements.

Loan-to-value compares the loan amount with the value basis specified in the question: LTV = loan ÷ value × 100%. In a purchase, a lender may use the lower of the purchase price or appraised value for underwriting, but a classroom problem should state its assumed denominator. If there are multiple liens, combined LTV may include more than the first mortgage.

A higher LTV means less borrower equity relative to the stated collateral value and can affect underwriting, pricing, and mortgage-insurance requirements. The ratio does not state the interest rate, monthly payment, or whether a loan is government-backed. For example, an 80% LTV does not itself prove that private mortgage insurance is required or not required; product and lender rules matter.

One loan point equals one percent of the loan amount. Points may be paid as origination fees, discount points to buy down the rate, or other charges. Points affect the effective cost of borrowing.

A loan point equals 1% of the loan principal, not 1% of the home's purchase price. A discount point is prepaid interest paid to obtain a lower note rate under a lender's pricing terms; an origination point or fee compensates for loan origination. The label and economic function matter, and lender terminology should be checked rather than assuming every point buys down a rate.

Compare points with the expected time the borrower will keep the loan. A lower rate can reduce scheduled payments, but upfront cost may not be recovered if the borrower sells or refinances soon. A break-even estimate divides the incremental upfront cost by the monthly payment savings, assuming the loan remains outstanding and ignoring taxes, discounting, and changing balances unless those are included.

Amortization is the gradual payoff of a loan through regular payments of principal and interest. A fully amortized loan reaches a zero balance at maturity through the regular payment schedule.

Amortization allocates level or otherwise scheduled payments between interest and principal so that a fully amortizing loan's balance reaches zero at the end of its stated term, assuming payments are made as scheduled and no terms change. Early payments on a typical fixed-rate mortgage contain a larger interest share because interest is calculated on a larger unpaid balance; the principal share generally grows over time.

A loan's amortization period and maturity date are related but not necessarily identical. A partially amortizing loan can require a balloon payment at maturity because scheduled payments have not repaid all principal. Interest-only periods also delay principal reduction. Always distinguish the payment schedule from the final contractual due date.

Negative amortization occurs when scheduled payments are insufficient to cover accrued interest, causing the loan balance to increase. This increases lender risk and borrower exposure.

Negative amortization occurs when a payment is less than the interest accruing for that period and unpaid interest is added to the principal balance. The borrower can make the required payment on time while still owing more than before; it is not simply a missed payment or ordinary interest accrual.

The effect depends on loan terms, payment options, rate changes, and any limits on balance growth. A loan may reach a contractual recast or payment cap that requires larger future payments. Analyze the balance rather than judging affordability solely from the initial payment, and do not assume every adjustable-rate loan negatively amortizes.

An ARM has an interest rate that changes periodically based on an index. Caps limit how much the rate can adjust in each period and over the life of the loan. ARM Rate = Index + Margin, subject to caps.

An adjustable-rate mortgage generally sets its rate using an index plus a contractual margin, then applies adjustment rules. The index is a benchmark that may change; the margin is specified in the loan terms and generally does not reset at each adjustment. Initial rate, adjustment dates, periodic caps, lifetime caps, and any floor all affect the rate actually charged.

A cap limits rate movement under the contract; it does not guarantee a low payment or prevent all payment shock. Some caps limit the interest rate while separate payment caps can create negative amortization if payments fail to cover interest. Review the note and disclosures for the exact index, margin, cap structure, and reset schedule.

Conventional loans are not government-insured or guaranteed. They conform to Fannie Mae/Freddie Mac guidelines (conforming loans) or exceed those limits (jumbo loans).

Conventional financing is not insured or guaranteed by FHA or VA. A conventional loan may be conforming—meeting applicable purchase eligibility standards set for sale to a government-sponsored enterprise—or nonconforming, such as a jumbo loan that exceeds a relevant limit or does not meet those standards. Conforming status is not a government guarantee.

Down payment, credit, mortgage insurance, underwriting, and pricing depend on the product and lender. Conventional loans can have private mortgage insurance when required by the loan structure, but not every conventional loan carries it. Do not use “conventional” as a synonym for fixed-rate, first-lien, or high-down-payment financing.

FHA-insured financing commonly involves upfront and periodic mortgage insurance premiums (MIP), with amounts and duration determined by current HUD rules. Premium structure and termination depend on program, loan term, loan-to-value, case-number assignment date, and transaction facts; do not treat one cancellation threshold as universal.

FHA-insured financing is made by participating lenders; FHA insures the lender against certain loss rather than lending the purchase funds directly to every borrower. FHA loans commonly involve an upfront mortgage insurance premium and a periodic premium, but the amount and duration depend on current program rules, loan term, loan-to-value, case assignment, and transaction type.

Do not call FHA mortgage insurance “PMI”: that term ordinarily refers to private mortgage insurance on conventional loans. Nor should a learner promise that FHA insurance always disappears at a particular equity level. HUD's current rules include different termination outcomes by case-number assignment date and other loan facts; borrowers should review the applicable case and servicer records.

VA-backed loans are guaranteed by the Department of Veterans Affairs for eligible borrowers and may permit no down payment subject to program and lender requirements. A one-time funding fee generally applies, but federal law and VA guidance exempt specified borrowers, including qualifying borrowers receiving or entitled to disability compensation and certain surviving spouses; confirm the borrower's status and loan facts.

VA guarantees eligible lenders a portion of qualifying loans; it does not mean every eligible borrower automatically receives identical terms or that the VA itself makes every loan. Zero down payment may be available when entitlement, appraisal, lender underwriting, and transaction requirements permit. VA-backed purchase loans generally do not require monthly mortgage insurance.

The funding fee is generally a one-time charge, can often be paid at closing or financed, and varies by loan type and other factors. It is not universal: VA lists exemptions for categories such as borrowers receiving or eligible for specified service-connected disability compensation, qualifying surviving spouses receiving DIC, certain pre-discharge ratings, and active-duty members with a Purple Heart by closing. Some disability awards effective before closing can support a refund; details matter.

Priority determines the order in which liens are paid from foreclosure proceeds. Generally, first to record has priority (first in time, first in right), subject to statutory exceptions such as property tax liens.

Lien priority determines the relative order in which competing secured claims are paid from collateral proceeds, subject to governing law and the facts. Recording can establish constructive notice and influence priority, but “first to record” is a study aid, not a complete answer for every lien. Statutory priority rules, subordination agreements, purchase-money rules, and notice issues can change the result.

A property-tax lien can receive statutory priority over many private liens even if it arose later; mechanics' lien priority can involve relation-back rules. Foreclosure by a senior lien may affect junior interests differently from senior interests. First identify lien type, attachment or recording, and any statute or agreement that alters the default ordering.

A due-on-sale clause allows the lender to demand full repayment when the property is transferred. Federal law preempts most state restrictions on enforcement of due-on-sale clauses.

A due-on-sale clause permits a lender, under its terms and applicable law, to accelerate the debt if the secured property or an interest in it is transferred without required consent. Federal law generally preempts state restrictions on enforcement, but the Garn–St Germain Act names transfers for which a lender may not exercise the option on qualifying residential property and specified conditions.

The listed protections include certain transfers on death, some transfers to a spouse or children, and creation of a qualifying subordinate lien, among other defined situations. Do not assume every transfer is protected or every assumption automatically triggers acceleration. Identify the type of transfer, property, occupancy, loan, and statutory exception; then read the contract and consult the lender.

Debt-service coverage ratio (DSCR) compares net operating income with annual debt service. A ratio above 1.00 indicates NOI exceeds debt service; a ratio below 1.00 indicates it does not. DSCR = NOI ÷ Annual Debt Service.

Debt-service coverage ratio compares a property's net operating income (NOI) with debt service for the same period: DSCR = NOI ÷ debt service. For an annual ratio, use annual NOI and annual principal-and-interest debt service. A ratio above 1.00 means the stated NOI exceeds the stated debt service; it does not mean the borrower has that percentage return on equity.

Use the lender's definition of NOI and debt service. Many underwriting calculations exclude income taxes, depreciation, and financing from NOI, while debt service may include scheduled principal and interest; reserves or other items may be handled differently by a particular lender. A DSCR below 1.00 indicates an operating-income gap against the stated debt service before considering other cash sources. Minimum DSCR requirements are underwriting and product-specific; the ratio alone does not establish approval.

RESPA governs certain settlement services for federally related mortgage loans. Key prohibitions include kickbacks and unearned fee splits for referrals of settlement services.

RESPA Section 8 and Regulation X apply to covered settlement-service business involving a federally related mortgage loan. They prohibit giving or accepting a thing of value under an agreement or understanding to refer settlement-service business and prohibit splitting charges except for services actually performed. A referral can be inferred from a pattern of conduct; it need not be written down.

The regulation contains defined exceptions, including bona fide compensation for goods or services actually furnished and cooperative brokerage or referral arrangements among real estate agents and brokers acting in that capacity. Those exceptions do not authorize a disguised payment for referrals, and a fee's source alone does not make a service compensable. Determine coverage, what work was done, and whether payment is reasonably tied to that work.

TILA (Truth in Lending Act) requires standardized disclosure of credit terms, including the annual percentage rate (APR). APR includes interest and certain other financing costs expressed as a yearly rate.

The Truth in Lending Act (TILA), implemented by Regulation Z, requires disclosures that help consumers understand the cost and terms of covered credit. The annual percentage rate expresses certain credit costs as a yearly rate, while the note rate is the contractual interest rate used to calculate interest. APR may include finance charges beyond the stated interest rate, so the figures can differ.

For many covered closed-end mortgage loans, the creditor provides a Loan Estimate within three business days after receiving an application and a Closing Disclosure at least three business days before consummation; coverage, definitions, and exceptions matter. TILA also provides separate rules for other transactions, including reverse mortgages and rescission rights in specified contexts. A broker should not treat every borrower or loan as subject to the same form and timeline.