Settlement Costs


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Closing Costs

Costs associated with the completion of a sale of real estate. Closing costs are not usually included in the sale price of the property. Some examples of closing costs are appraisal fees, deed-recording fees, and applicable taxes. Mortgage loans often include money for closing costs. They are also called settlement costs.

Settlement Costs

Total costs charged to the borrower that must be paid at closing, by the borrower, the home seller, or the lender.

In dealing directly with a lender, settlement costs can be divided into the following categories:
1. Fees paid to lender.
2. Lender-controlled fees paid to third parties.
3. Other fees paid to third parties.
4. Other settlement costs.

Fees Paid to Lender: Lender fees fall into two categories: those expressed as a percent of the loan and those expressed in dollars.

Fees Expressed as Percent of Loan: These consist of points and origination fees. Origination fees are points in disguise. Reporting services that publish information on mortgage rates and points do not show origination fees, so lenders that charge an origination fee may appear to have lower fees. This is pure gamesmanship. The borrower's concern is the total of all charges expressed as a percent of the loan amount, whatever they are called.

Lender Fees Expressed in Dollars: Some of the common lender fees expressed in dollars cover processing, tax service, flood certification, underwriting, wire transfer, document preparation, courier, and lender inspection. They are almost always itemized, a deplorable practice that goes back to the days when interest rates were regulated and lenders had to justify their fees in terms of reimbursement for costs.

From the borrower's perspective, what these fees are called doesn't matter, and whether they are cost-justified doesn't matter. All that matters is their sum total, which borrowers should use in shopping.

Shoppers take account of points in selecting a lender because lenders always report points alongside the interest rate. Dollar fees and origination fees, however, are not reported in the media and generally are not volunteered by lenders. For this reason, shoppers often fail to consider them in selecting a lender. Trying to negotiate them afterwards is usually fruitless.

Shoppers should ask for dollar fees and should expect the lender to guarantee them through to closing. In contrast to guaranteeing a rate and points, which exposes a lender to market risk, there is virtually no risk in guaranteeing dollar fees. The same is true of an origination fee.

Some retail lenders guarantee their dollar fees now. These include ELOAN.com, IndyMac.com, HomeLoanCenter.com, Mortgage.com, Mortgage.etrade.com, and Countrywide.com. If they can do it, any lender can, and they will if shoppers demand it. Under HUD proposals pending at the time of writing, the guarantee would be mandatory.

Lender-Controlled Fees to Third Parties: These are fees for services ordered by lenders from third parties and include the costs of appraisals, credit reports, and (when needed) pest inspections.

Lenders know the prices of these services and can easily guarantee them in addition to their own fees. Countrywide.com, Mortgage.com, and Mortgage.etrade.com include appraisals and credit reports in their guarantees.

Other Fees Paid to Third Parties: These fees are not controlled by and may not be known by the lender. The most important are title-related services and settlement services. If you are in an area in which it can pay to shop for them, you can do it after selecting the lender. Mortgage.com includes third-party fees in its guarantee, except for charges of governments.

Other Settlement Costs: These are a miscellany of charges, which require little vigilance by the borrower.

• Government charges, such as transaction taxes, are what they are.

• Per diem interest is interest for the period between the closing date and the first day of the following month. At worst, the  lender might try to tack on an extra day or two.

• Escrow reserve is your money placed on deposit with the lender so the lender can pay your taxes and insurance. The amount is based on a HUD formula.

• Hazard insurance is your homeowner's policy, which you purchase from a carrier of your choice.

Good Faith Estimate (GFE): Under the Real Estate Settlement Procedures Act of 1974 (RESPA), lenders are required to provide borrowers with a Good Faith Estimate of settlement costs. It is a confusing and largely useless document. The GFE encourages itemized pricing by providing space on the form for any expense category a lender wishes to use. Further, the GFE intermixes lender charges with charges of third parties (for insurance, taxes, and the like) and total lender charges are not shown anywhere. The GFE thus provides borrowers with all the detail for which they have no use, but no total, which is the only number they really need.

Furthermore, because some third-party charges are not known with certainty until late in the process, all costs are viewed as “esti-
mates,” including the lenders' own charges, which obviously are known with certainty. Viewing lender charges as estimates encourages the practice of some less scrupulous loan officers and mortgage brokers of “overlooking” certain charges at the outset, only to discover them later when it is too late for the borrower to back out.

Strategy in Shopping Lenders: In shopping lenders, you want the total of points, including the origination fee if any, dollar fees, and lender-controlled fees paid to third parties. Ask if they will guarantee all these fees except points in writing.

The common mistake that shoppers make is to select a lender without knowing any of the lender charges except points, then try to negotiate other charges afterwards. Typically they do this after they receive a Good Faith Estimate (GFE).

But challenging individual cost items is not an effective way to control lender fees. Typical borrowers have little to no factual basis
for challenging a cost item. Even if they have such knowledge, their bargaining power is weak. Having already selected the lender, few are prepared to walk from the deal, and the lender knows this.

Furthermore, even if a determined borrower succeeds in bludgeoning the lender into making a change, the determined lender can get it back somewhere else. The costs shown on the GFE are “estimates” and can be different at closing than they were the day before closing. This is a game the borrower can't win.

Shopping Total Settlement Costs: Some shoppers adopt a different strategy, which seems to make a lot of sense. They reason that what matters is total settlement costs, so they select the lender on that basis. Instead of shopping lender fees, they shop total settlement costs.

Indeed, this approach is the foundation of new rules regarding settlement costs that have been proposed by HUD. Under these rules, borrowers will be able to obtain one binding price covering all settlement costs from lenders electing this option. Until that happens, however, borrowers can't use this strategy effectively because lenders will not commit to any figures on total settlement costs that they might quote to shoppers.

Suppose, for example, you are deciding between 7% 30-year fixed-rate mortgages offered by two lenders. Lender A quotes total settlement costs of $4,000, compared with $4,200 for lender B. Lender A looks like the better deal.

Closer inspection reveals, however, that A's own fees are $2,000 and A has estimated other costs of $2,000. B's own fees, in contrast, are $1,900 and B has estimated other costs at $2,300. The correct choice is B because B has the lower lender fees, which lenders can guarantee. The other costs are estimates. While we don't know which is closer to the mark, we do know that the actual figure will almost certainly not be affected by whether the shopper selects A or B.

Since lenders being shopped for total settlement costs have an incentive to err on the low side, we can guess that B's estimate probably will be closer to the mark. Whether A deliberately low-balled to get the business or made a “good faith” mistake, there is no way to know.

The bottom line is that, until HUD changes the rules, shoppers who want to control their settlement costs should focus on lender fees only. The alternative is to shop for a no-cost loan, on which lenders do accept responsibility for most settlement costs. The price is a higher interest rate, not a good deal for people who expect to be in their homes a long time. See No-Cost Mortgage.

Dealing with a Mortgage Broker: If the shopper is dealing with a mortgage broker rather than a lender, the process is more complicated in the sense that the broker's fee is one more settlement cost to consider. But it is simpler in the sense that the broker keeps the lender honest on fixed-dollar fees.

While some retail lenders view fixed-dollar fees as an easy way to generate additional revenue from unwary borrowers, wholesale
lenders don't because it would cause them problems with brokers. For this reason, lender fees differ very little from one wholesale
lender to another. Dealing with a mortgage broker pretty much eliminates fixed-dollar lender fees as an issue to the shopper. Mortgage brokers can also help borrowers find third-party services at competitive prices.

The upshot is that shoppers who deal with a mortgage broker can shift their focus from shopping settlement costs to negotiating the broker's fee. Just make sure that the broker fee includes any payment to the broker from the lender. For example, if you agree on a fee of $3,000 and the broker gets $1,500 from the lender, your payment should be the difference of $1,500. Upfront Mortgage Brokers operate this way as a matter of course, but many other brokers are willing to do business this way with educated borrowers who understand the value of broker services.

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