By Eric Erickson, partner in Viking Mortgage Company. He has been helping homeowners and real estate investors close their mortgage transactions for the past 8 years. He can be reached at
1-888-738-3350.
Well -- what are these excessive, exorbitant, outrageous fees that lenders charge to close a loan transaction? Why are there closing costs at all? I just don?t get the reason for closing costs -- when it seems most lenders advertise no cost loans.
The simple answer is all the parties involved in any loan transaction should and will be paid. This begs the question as to who is involved and who pays them. The second part of the above question is easy to answer. The borrower always pays for all costs involved in a loan transaction. Who, what and how they are paid is what this article will try to explain.
The first thing to understand is that there are different costs associated with each of the different elements in a loan transaction. Let's break down what is involved in the loan process and the final closing and who gets paid.
When you initially apply for a residential loan you are given a good faith estimate. This estimate should mirror the final cost breakdown of the loan transaction that will be given to you at closing -- the HUD-1 settlement statement. The good faith estimate is just what the title implies -- an estimate. There are three areas of costs that should be described: the mortgage broker and lender fees, vendor costs, and prepaid interest/escrows.
The mortgage broker and lender fees that may be charged to you include points, underwriting fee, flood certification fee, processing fee, administration fee, etc. I have put both the mortgage broker and lender together. The reason for this is that if you use a mortgage broker the costs should be the same as going to a lender directly. The mortgage broker receives wholesale pricing from their lenders. The mortgage broker fulfills the same function as a lender?s retail branch office and assumes the expenses associated with maintaining an office. So how are they each paid?
First, points -- a point is a percentage of the loan amount. One point is equal to 1% of the loan amount. If you borrower $100,000 and are charged one point you will pay $1,000. Points have a direct relationship to the interest rate being quoted on any given day. Quickly, the bond market that is constantly changing, just like the stock market, determines interest rates. Lenders send out wholesale rate sheets to their approved brokers each day. These rate sheets outline interest rates offered within each of their loan programs parameters. Generally, points are paid to lock in a lower interest rate; conversely you will receive a higher interest rate if you pay no points. I will continue this discussion in another article. The other charges are to pay for fixed costs associated with processing and closing a loan. Lenders will charge for underwriting, administration, etc. These costs differ from lender to lender. Some lenders lump all their fees into one consolidated fee others will break out each fee. Basically, the reason for the lenders charging these fees is two fold. First, the mortgage industry has become so competitive that the interest rates offered to mortgage brokers leave very thin margins for lenders to make a profit. A lender still has to maintain an underwriting department, closing department, management, and wholesale sales staff. The lenders have found that to maintain competitive low rates for the borrower, they have to charge flat fees to make up the difference. The other part is there are third party costs that have to be paid, for example, flood certification. This certification is now required on all loans.
Vendors can be broken down into three main components. The first two are credit agencies and appraisers. Credit reports have come down in cost with the use of automated underwriting. The appraiser?s cost depends on the type of property. One thing you should understand is that residential appraiser fees have not changed in the nine years I have been originating loans. It is funny to me that borrowers still complain about appraisal fees when in general the market hasn?t allowed the appraiser to give himself a raise in all these years.
The third component is the attorney fees to close the loan for the lender and mortgage broker. Their fees are mostly pass through costs. Title exams are performed to check the title to a property. Title insurance is required to protect the lender and borrower from future tile problems. Documents need to be recorded at the registry and there is a charge for this. The town charges to obtain a municipal lien certificate that shows what real estate taxes are outstanding – remember unpaid taxes can always become a first lien on any property. A plot plan needs to be obtained to determine property lines, existing structures, etc. Finally the attorney should be paid for their time and service to the lender and borrower.
Lastly, there is prepaid interest and escrows collected. I don?t consider these items to be a part of the general closing costs because they are pass through expenses that will have to paid. Prepaid interest is simple interest charged at the closing for the remaining days in the month the loan closes. The reason for this is that mortgage payments are made in arrears or the month the first payment is made is applied to the previous month. Effectively, in order to set a loan up for servicing, the first month's payment is skipped and paid the next month, therefore one month's interest is always owed till the end of the loan?s term. Thus, there is interest owed for the days the loan is held in the month it is closed and is paid at the closing. Whether or not a lender requires a borrower to escrow/deposit money to pay for real estate taxes or homeowner's insurance, these two items need to be paid at closing. Generally, a borrower is required to pay for real estate taxes owed to date and whatever may be due within 60 days of the closing. Homeowner's insurance is required to be paid in full for one year prior to the closing and, if escrowed, the lender will collect two or three months in advance to fund the escrow account to pay the premium when it becomes due in the next year. Lastly, if private mortgage insurance is required on the loan then this will be escrowed along with the real estate taxes and home insurance.
So now you understand that there are closing costs and they will be paid by the borrower. Remember there is no such thing as a free lunch. One way or another, the costs associated with originating, processing, underwriting and closing a loan will be borne by the borrower, either in a higher interest rate where the lender pays for these costs from a higher premium earned on selling the loan or directly by the borrower at closing.