Real Estate Financing Terms Every Student Must Know

Real Estate Financing Terms Every Student Must Know

Financing questions make up 10-15% of most real estate exams. The terminology can be overwhelming, but every term follows a logical pattern once you understand the big picture. This guide explains 30+ financing terms in plain language and tells you exactly why each one matters on exam day.

Quick reference: Bookmark our Financing Cheat Sheet for a printable one-page summary of these terms.

The Big Picture: How Real Estate Financing Works

Before diving into individual terms, understand the flow:

• Borrower gets a loan from a lender (bank, credit union, mortgage company)
• Borrower signs a promissory note (the promise to repay) and a security instrument (mortgage or deed of trust)
• Lender may sell the loan on the secondary market to Fannie Mae, Freddie Mac, or Ginnie Mae
• Borrower makes monthly payments until the loan is paid off or the property is sold

Every financing term fits somewhere in this flow. Let's break them down.

Loan Documents

Promissory Note

The borrower's written promise to repay the loan. This is the evidence of the debt. It contains the loan amount, interest rate, payment schedule, and penalties for default. The promissory note is a negotiable instrument — it can be bought and sold.

Exam tip: The promissory note creates personal liability. Even if the property is foreclosed, the borrower may still owe money if the sale doesn't cover the full debt (called a deficiency judgment).

Mortgage

A security instrument that pledges the property as collateral for the loan. Used in "lien theory" states where the borrower retains title and the lender holds a lien.

Exam tip: A mortgage involves TWO parties — the mortgagor (borrower) and the mortgagee (lender). Remember: the "or" gives, the "ee" receives.

Deed of Trust

An alternative security instrument used in "title theory" states. Involves THREE parties:

• Trustor (borrower) — conveys title to the trustee
• Trustee (neutral third party) — holds title until loan is repaid
• Beneficiary (lender) — benefits from the arrangement

Exam tip: The key advantage of a deed of trust is non-judicial foreclosure — faster and cheaper than the judicial process required for mortgages.

Loan Types

Conventional Loan

A loan NOT insured or guaranteed by a government agency. Typically requires 3-20% down payment. If down payment is less than 20%, PMI is required.

FHA Loan (Federal Housing Administration)

Government-insured loan designed for first-time and lower-income buyers. Features:

• Down payment as low as 3.5%
• More lenient credit requirements
• Requires both upfront and annual MIP (Mortgage Insurance Premium)
• Property must meet FHA minimum property standards

Exam tip: FHA does not lend money — it insures loans made by approved lenders.

VA Loan (Department of Veterans Affairs)

Government-guaranteed loan for eligible veterans and active military. Features:

• No down payment required
• No PMI requirement
• Funding fee (can be rolled into the loan)
• Must obtain a Certificate of Eligibility (COE)

Exam tip: VA does not insure — it guarantees a portion of the loan. Different word, different program.

USDA Loan

Government-backed loan for rural and suburban properties. No down payment required. Income limits apply.

Jumbo Loan

A loan that exceeds the conforming loan limit set by the FHFA (Federal Housing Finance Agency). In 2026, this limit is $766,550 in most areas. Jumbo loans typically require higher down payments and stronger credit scores because they cannot be sold to Fannie Mae or Freddie Mac.

Key Ratios

Loan-to-Value Ratio (LTV)

Formula: Loan Amount / Property Value (or purchase price, whichever is LOWER) = LTV

LTV determines:

• Whether PMI is required (LTV > 80%)
• Loan approval likelihood
• Interest rate (higher LTV = higher rate)

Debt-to-Income Ratio (DTI)

Formula: Total Monthly Debt Payments / Gross Monthly Income = DTI

Two types:

• Front-end (housing) ratio: Housing expenses only / Gross income. Conventional max: 28%
• Back-end (total) ratio: All debts / Gross income. Conventional max: 36%

Exam tip: FHA is more lenient — allows up to 31% front-end and 43% back-end. Practice these ratios in our Real Estate Math Practice problems.

PMI (Private Mortgage Insurance)

Insurance that protects the lender (not the borrower) when LTV exceeds 80%. Key facts:

• Required on conventional loans with less than 20% down
• Can be canceled when LTV reaches 78% (automatically) or 80% (by request)
• FHA calls it MIP (Mortgage Insurance Premium), and it cannot be canceled on loans with less than 10% down

Interest and Payments

Amortization

The process of paying off a loan through regular payments of both principal and interest. In a fully amortized loan, early payments are mostly interest, and later payments are mostly principal. This is why borrowers build equity slowly at first.

Fixed-Rate Mortgage

Interest rate stays the same for the entire loan term (typically 15 or 30 years). Monthly payment never changes. Provides predictability.

Adjustable-Rate Mortgage (ARM)

Interest rate changes periodically based on a market index plus a margin. Key terms:

• Index — the market benchmark (e.g., SOFR, Treasury rate)
• Margin — the lender's markup (e.g., 2.75%)
• Adjustment period — how often the rate changes (e.g., annually)
• Caps — limits on rate increases (periodic cap, lifetime cap, payment cap)
• Teaser rate — initial below-market rate to attract borrowers

A "5/1 ARM" means the rate is fixed for 5 years, then adjusts every 1 year.

Discount Points

Prepaid interest paid at closing to buy down the interest rate. Each point costs 1% of the loan amount and typically reduces the rate by 0.25%.

Example: On a $300,000 loan, 2 points = $6,000 upfront, reducing the rate from 6.5% to 6.0%. Exam tip: Points are tax-deductible as prepaid interest in the year paid (for a purchase) or over the life of the loan (for a refinance).

Origination Fee

A fee charged by the lender for processing the loan. Typically 0.5-1% of the loan amount. Unlike discount points, origination fees do NOT reduce the interest rate.

Escrow

Escrow Account (Impound Account)

An account managed by the lender to collect and pay property taxes and insurance on the borrower's behalf. A portion of each monthly payment goes into escrow.

Why it matters on the exam: Escrow accounts protect the lender's investment by ensuring taxes and insurance are always current. They are often required when LTV exceeds 80%.

Federal Regulations

RESPA (Real Estate Settlement Procedures Act)

Protects borrowers in residential mortgage transactions. Key requirements:

• Lender must provide a Loan Estimate within 3 business days of application
• Lender must provide a Closing Disclosure at least 3 business days before closing
• Prohibits kickbacks and unearned fees
• Limits escrow account deposits
• Requires disclosure of loan servicing transfers

TILA (Truth in Lending Act) / Regulation Z

Requires lenders to disclose the true cost of borrowing, including:

• APR (Annual Percentage Rate) — the total cost of the loan expressed as a yearly rate
• Finance charges
• Payment schedule
• Total of payments

Exam tip: TILA gives borrowers a 3-day right of rescission on refinances and home equity loans (NOT on purchase money mortgages for primary residences).

TRID (TILA-RESPA Integrated Disclosure)

Combined TILA and RESPA disclosure requirements into two standardized forms:

• Loan Estimate — replaces the old Good Faith Estimate and initial TIL disclosure
• Closing Disclosure — replaces the old HUD-1 and final TIL disclosure

ECOA (Equal Credit Opportunity Act)

Prohibits discrimination in lending based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance.

The Secondary Market

What Is It?

The secondary market is where lenders sell existing loans to investors. This frees up capital so lenders can make more loans.

Fannie Mae (FNMA — Federal National Mortgage Association)

A government-sponsored enterprise (GSE) that buys conventional loans from lenders, packages them into mortgage-backed securities (MBS), and sells them to investors.

Freddie Mac (FHLMC — Federal Home Loan Mortgage Corporation)

Similar to Fannie Mae — another GSE that buys conventional loans and creates MBS. Together, Fannie and Freddie set conforming loan guidelines (maximum loan amounts, credit requirements, etc.).

Ginnie Mae (GNMA — Government National Mortgage Association)

A government agency (not a GSE) that guarantees MBS backed by government-insured loans (FHA, VA, USDA). Ginnie Mae does NOT buy or sell loans — it only guarantees the securities.

Exam tip: Fannie Mae and Freddie Mac deal with conventional loans. Ginnie Mae deals with government loans. This distinction is frequently tested.

Terms That Sound Alike but Aren't

7 Financing Facts Most Students Get Wrong

• FHA insures, VA guarantees — different words, different programs
• PMI protects the lender, not the borrower
• Discount points are tax-deductible, origination fees are not
• LTV uses the LOWER of purchase price or appraised value
• TILA right of rescission does NOT apply to purchase money mortgages
• Fannie/Freddie = conventional loans, Ginnie Mae = government loans
• A promissory note creates the debt, the mortgage/deed of trust secures it

Study Resources

• Financing Cheat Sheet — one-page printable summary
• Real Estate Math Practice — LTV, DTI, and mortgage calculations
• Math Formulas Cheat Sheet — all exam formulas
• Practice Questions — test your knowledge

Start practicing financing questions →