March 5, 1999,
Rewritten February 15, 2003
Settlement costs are one of
the most confusing and irritating features
of home mortgages in the US. Confusion arises out of the many different types of costs involved, which
can vary from state to state and also from lender to lender.
Confusion also arises over how to deal with them. Are some
settlement costs negotiable, and if so which? Should they be
shopped, and if so, how? This article deals with these questions.
makes a difference whether the shopper is dealing with a lender or with a
mortgage broker. I�ll deal
with the lender case first.
WITH A LENDER
costs can be divided into the following categories:
Fees paid to lender
Lender-controlled fees paid to third parties
Other fees paid to third parties
Other settlement costs
paid to lender (henceforth
�lender fees�) should be the shopper�s major focus.
Lender fees consist of points and dollar fees.
an upfront charge expressed as a percent of the loan amount.
An origination fee is the same except it is not related to the
interest rate as points are.
are those specified in dollars. Some
of the common fees are for: processing, tax service, flood certification,
underwriting, wire transfer, document preparation, courier, and lender
inspection. But from a
shopping perspective, what they are called doesn�t matter, and whether
they are justified doesn�t matter.
All that matters is their sum total.
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
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.
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
paid to third parties for
services ordered by the lender. These 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.
fees paid to third parties
are not controlled by, and may not be known by the lender. The most
important of these 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.
are a miscellany of charges, which require little vigilance by the
charges, such as transaction taxes, are what they are.
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.
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.
insurance is your homeowner�s policy, which you purchase from a carrier
of your choice.
In sum, in
shopping lenders, you want the total of points including origination fee
if any, dollar fees, and lender-controlled fees paid to third parties.
Ask if they will guarantee all fees except points in writing.
Strategy: 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), which
itemizes all the settlement costs including all lender charges.
challenging individual cost items is not an effective way to control
lender fees. The typical
borrower has 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.
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.
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.
approach is the foundation of new rules regarding settlement costs that
have been proposed by HUD, which could well be enacted in 2003.
Under these rules, borrowers will be able to obtain one binding
price covering all settlement costs from lenders electing this option.
happens, however, borrowers can�t use this strategy effectively.
Lenders will not commit to any figures on total settlement costs
that they might quote to shoppers. The
reason is that today, lenders have complete knowledge and control only
over their own charges. They
don�t control and don�t necessarily know all third party charges,
which is why the GFE is an �Estimate�.
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 to $4,200 for lender B.
Lender A looks like the better deal.
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.
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.
bottom line is that until HUD changes the rules, shoppers who want to
control their settlement costs should focus on lender fees only.
WITH A MORTGAGE BROKER
the shopper is dealing with a mortgage broker rather than a lender, the
process is both more complicated and simpler. It is more complicated in
the sense that there is one more significant fee to consider: the
broker�s. It is simpler in
the sense that the broker keeps the lender honest on fixed-dollar fees.
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 problems for their 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
is that shoppers who deal with a mortgage broker can shift their focus
from shopping settlement costs to negotiating with the broker.
I have urged shoppers on many occasions to approach the broker as a
service provider who gets paid a fee that is negotiated at the outset.
This is in contrast to the usual procedure of adding the broker�s
fee to the points charged by the lender.
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.
Jack Guttentag 2003