Real Estate Financing & Valuation Explained: Deed of Trust, FHA, Cap Rate (CA 2026)

Financing and valuations sound intimidating, but the exam only wants a few clear ideas, including one you can literally compute. Let's learn them. Financing is about 9% of the exam and valuation about 14, together. A big slice worth getting right.

In California, the main loan instrument is the deed of trust. It has three parties. The trustor, who is the borrower, the trustee, a neutral third party who holds bare legal title, and the beneficiary, who is the lender? Think of the trustee like a neutral middleman holding the key to your title.

They keep that bare legal title until the loan is paid off, then hand it back to you with a reconvance. Trustor borrows, trustee holds, beneficiary lends. So, exam version. In a deed of trust, who holds the bare or naked legal title?

The trustee, the neutral third party? Yes, the trustor, the borrower? No, they have possession, not legal title. The beneficiary, the lender?

No, the county recorder. No, the rule, trustor borrows, trustee holds the naked title, beneficiary lends. Now a loan program people mix up. Under an FHA loan, the FHA does not lend you any money.

It ensures the lender against loss if you default. You pay mortgage insurance for that, and the loan is. Test it. Under an FHA loan, what does the FHA actually do?

Ensure the lender against loss? Yes, lend the money directly? No, it never funds a loan. Guarantee the loan like the VA does.

No, the VA guarantees the FHA insures. Set the interest rate? No, the rule, FHA insures, VA guarantees, and neither one lends directly. On to valuation.

There are three approaches to value. Sales comparison is best for homes. The cost approach is best for new or special purpose buildings like schools and churches. And the income approach is best for rentals and it's the one with a formula.

Here's that formula step by step. Value equals net operating income divided by the cap rate. First, find the net operating income, that's income minus operating expenses, and you never subtract the mortgage. Second, divide it by the cap rate, $60,000 of income at an 8% cap rate.

Third, read the value, $750,000, which brings up the classic trap. When you compute net operating income, which expensed you not deduct, debt service, the mortgage principle and interest, correct, you never subtract it. Property taxes, no, those come out. Insurance, no, that comes out.

Management fees, no, those come out too. The rule, net operating income is income minus operating expenses, never the mortgage. Recap, the deed of trust has a trustor, a trustee who holds the naked title and a beneficiary. FHA ensures VA guarantees.

The three approaches are comparison for homes, cost for special buildings and income, where value equals net operating income divided by the cap rate. Now test yourself, free California financing and valuation questions at dot com in English, Chinese and Spanish.