Definition of "Settlement Costs"

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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: Fees paid to lender; Lender-controlled fees paid to third parties; Other fees paid to third parties; 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. 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. 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. 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; 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


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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. 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 thatwhat 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. 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.

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