Getting a mortgage is a complex transaction. Behind the scenes, the process of completing a mortgage requires services from a range of different providers. Mortgage lending guidelines state that any company providing a service on your loan (and charging for it) must be accounted for and documented within your loan file.
Where can you find your closing costs?
Your mortgage company will typically collect the necessary documents pertaining to these charges and deliver a Loan Estimate. By law, a Loan Estimate is provided to you within three days of your loan application. This will be your first opportunity to see a detailed breakdown of the closing costs you can expect for your purchase or refinance. While some charges shown can change by up to 10 percent or more, other charges must be exact and cannot change between the time you make your application and your closing date.
When you first view the Loan Estimate, it may seem a bit confusing as you’ll find charges from numerous third parties – and you may not recognize the names or services they offer.
Fortunately, taking a short amount of time to understand the different categories of closing costs, fees and points will vastly improve your chances of getting a great deal because you will be an informed consumer. So read on!
1. Recurring vs. Non-Recurring Costs
When it comes to the costs of your mortgage loan, certain costs will occur again (recurring), while others are associated with the transaction only and are simply one-time charges (non-recurring).
Why is this important? It is important to differentiate these costs, as recurring costs will typically be associated with owning the actual property (regardless of which mortgage company closes your loan) and should be factored into your ongoing budget. Non-recurring costs are associated purely with the transaction and will not come up again.
Recurring costs include prepaid interest charges which are, in reality, your very first mortgage payment! (Wasn’t that exciting!) Normally, mortgage payments are made in arrears, which means that on the first day of every month, you are paying for the previous month’s interest accumulation and a bit of the principal balance.
When it comes time for your closing, you’ll see an amount listed as prepaid interest. Prepaid interest is a “per diem” (per day) charge of interest between the day your loan closes up to the first day of the following month. This is the one and only time you will pay for interest ahead of time when it comes to your mortgage loan.
Example: Suppose your settlement date is on the 20th of a given month. Your settlement agent will collect ten days of interest (assuming 30 days in the month) at the time of closing. Again, this is your very first mortgage payment, and it is collected in advance just this one time.
Another form of recurring costs involves your property taxes and homeowners insurance. A full year of homeowners insurance premium is typically collected and paid to your insurance company at the time of closing. Also, you’ll need to pay some amount of property taxes that may be due in the coming year. Property tax collection times and frequency will vary by state or county and include funds paid to the local school district, county and city.
Property taxes and homeowners insurance are recurring costs because you must continue to pay them as long as you are in your home – even if you pay off your mortgage balance completely!
If you decide (or are required to) escrow for these two items, your first regularly scheduled mortgage payment after closing (and all others) will include one-twelfth (1/12th) of your yearly tax and homeowners insurance amount. These incremental payments will be accumulated by the mortgage company and paid when due. If you receive a tax bill or insurance bill when you are escrowing these items it is always a good idea to forward to your mortgage company immediately.
Non-Recurring costs are those costs associated with the closing of your mortgage loan which will not occur again. Typically, these are referred to as transaction costs. Examples include a lender/broker fee (could be called “Origination Fee”), an appraisal fee, and document preparation fees.
In some states, you may also be required to pay a state-mandated transaction fee at closing. In the state of Pennsylvania, for example, a two percent (2%) transfer tax is charged by the State for each home purchase. This amount is typically split between the buyer and seller and is not a lender charge.
2. Lender Fees vs. Non-Lender Fees
When it comes to shopping for the best mortgage deal between lenders, you’ll want to pay attention to fees payable to the lender versus fees payable to third parties. Why? Lender fees and interest rates are the true “apples to apples” numbers you can compare when shopping for your mortgage provider. Accordingly, lender fees should be considered separately from third party fees which are payable to different companies and cannot be “padded” by the lender.
Note: You can always shop for third party services such as appraisal services, title companies and home inspectors, after you select a mortgage lender.
A lender or broker fee will appear in black and white when you are comparing offers or when you are viewing a Loan Estimate. This may also appear as a percentage of your loan amount. In either case, this amount will be paid directly to the lender or broker in exchange for providing their services.
When two separate lenders provide the same interest rate, the offer that includes lower lender fees is the lower cost option of the two.
Providing an interest rate above a “par rate” to earn yield spread (YSP) is another way money is generated for mortgage lenders or brokers. Similar to a retail store owner sourcing and purchasing clothing at wholesale prices and then selling at a retail markup price, the mortgage lender or broker sources your loan on the wholesale market and charges a retail markup interest rate.
Non-lender fees include charges for services such as title insurance, an appraisal or abstract. On your Loan Estimate, as well as on your Closing Disclosure, the lender charges will be located at the top of the document and all non-lender fees will be detailed below. Remember that you can shop for these third party services – just as you would a mortgage lender.
3. What are Points?
A point (discount point) is a percentage of the loan amount you can pay upfront to reduce, or discount, the interest rate on your loan.
Example: A loan officer might quote to you a 30-year fixed rate at 4.75% with no points, but if you want to get a lower rate, say 4.50%, you’ll be asked to pay one point, or one percent of the amount to be borrowed, at closing.
Points are a form of prepaid interest to the lender, and different from an origination fee or other fee, the lender is indifferent if you select to pay them. This is because the lender earns the same amount of interest either way. Either you pay a slightly higher interest rate over time, or you pay the interest upfront via a discount point and pay less interest over the life of the loan.
Lenders can provide an array of interest rate options based upon the number of points purchased. They can offer a particular interest rate for 0 points, another interest rate for 1 point, and so on. To determine whether or not paying points makes sense in your situation, it is a good idea to compare the total funds required at closing and the difference in monthly payments at various rate and point combinations. You may also want to think about how long you intend to be in the home and if paying interest ahead of schedule makes good financial sense.
Tip: Your lender can usually offer a lender credit toward closing costs if you elect to pay a higher interest rate over time. The higher rate generates extra revenue for the lender and they use these funds to pay some or all of your fees. When you hear about lenders advertising a “no closing cost loan,” this is how they do it.
Now that you know a bit more about the types of mortgage closing costs – be sure to compare them along with the interest rate when mortgage shopping. Your choice of a mortgage lender and loan program will have a lasting impact on your budget – so shop for a great loan and set yourself up for financial success by getting the best deal possible.
Tip: Compare mortgage lenders safely and easily at MortgageCS.com. Once your account is set up – you can anonymously obtain detailed quotes for your exact situation.