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Mortgage Closing Costs: 3 keys to successful shopping

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

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

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. 

Lender Fees

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

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.

When to Refinance, and When NOT To

Interest rates have been in their narrow range for some time now, after hitting record lows in late 2012. The average 30 year fixed rate hit 3.31% that year according to Freddie Mac’s weekly mortgage rate survey.

You may not be able to find a 3.31% rate today (at least without paying additional fees), but you can still get very close considering the recent few decades of interest rates. Many homeowners have taken advantage of lower rates and refinanced their mortgages to enjoy lower monthly payments, but there are still more who, for whatever reason, haven’t decided whether or not a refinance makes sense.

There are ways to know whether a refinance is a good idea, and it’s not always about the interest rate. Here are some basics to keep in mind when considering a new mortgage:

Interest Rate & Payment

This is the most common reason people refinance. When mortgage rates fall, homeowners soon see solicitations from mortgage lenders announcing the new opportunity to lower their monthly payments. While that certainly makes sense in many cases, it’s not the right solution for everyone, every time. You may have heard it’s a good idea to refinance if rates are say, 1.00% below what you currently have, but the rate is only part of the equation. If you have a 30-year fixed rate of 5.00% and rates fall to 4.00%, then that so-called “rule of thumb” would kick in. But that’s not the only consideration when evaluating a possible refinance.

Instead, you must first weigh the difference in monthly payments compared against the fees associated with getting the new mortgage, then determine how long it would take to recover those closing costs. Let’s look at a basic example. Let us suppose that you have a mortgage balance of $200,000 and a 30-year fixed rate at 4.00%. That puts your current monthly principal and interest payment at $954 per month.

Now imagine interest rates have fallen to 3.25%. The new monthly payment would fall to $870, for a monthly savings of $84 each month. That’s an attractive number, but how much will it cost to get that lower rate? Let’s say that lender fees are $1,000, and other third party charges add up to $3,000 for a $4,000 total. If you divide the monthly savings into the closing costs you get 47.62, or almost 48 months to recover those fees with the lower payment. Is that too long?

Possibly. Some think a recovery term of two to three years makes the most sense, and if you’re going to own the property for at least that long, then a refinance might be a good idea. When refinancing a mortgage because rates are lower, you must also consider the costs involved.

Note: It is also important to consider the costs of re-amortizing (or starting over) on your loan term. These details are not covered in this particular article –however here is a brief: If you are two years into a 30-year loan and refinance into another 30-year loan, you are resetting the 30-year period, meaning you have 30 more years to pay your new amount compared to just 28 years of paying the older mortgage payment.

To reduce costs, it is a popular option to obtain a lender credit at the time of closing. Mortgage companies are typically willing to increase your interest rate in exchange for lower closing costs. Using the example from above, if you increased the new rate from 3.25% to 3.50%, the monthly payment would still be $56 lower. At the same time, the lender would provide you with a credit of $2,000, or 1% of the loan amount. In this instance, the time it would take to recover your closing costs will be under three years, or 35 months- certainly a more attractive option.

If you are wondering how this works, you are not alone. In the same fashion that you can lower a 30-year fixed rate by paying discount points, you can also select to increase your interest rate and have the lender pay some of your costs in the form of a lender credit. Mortgage lenders have no preference on which option you take – so explore your options before making a final decision.

Changing Loan Terms

Another popular reason to refinance is to shorten the term of an existing loan. Reducing the term of a mortgage loan saves a considerable amount of interest, yet it also typically increases the monthly payment. Most borrowers opt for a 30-year fixed mortgage due to the lower monthly payments, even though it will take twice as long to completely pay off the balance.

Continuing our example from above, a $200,000 mortgage with a 30-year fixed rate of 3.50% will require a payment of $898 while a 15-year loan at 3.25% will require a payment of $1,405 per month. While the difference in monthly payment may be significant, so is the impact on how quickly the loan is paid down. Just five years into these loans, the principal balance remaining on the 15-year loan is nearly $36,000 lower, when compared to the 30-year loan option ($179,394 on the 30-year loan compared to $143,814 on the-15 year).

Sometimes the jump in payment between a 30-year fixed rate to a 15-year is too great, so much so that a borrower may not qualify for the shorter-term loan. Fortunately, there are other options that many may not know about. Mortgage lenders typically also offer fixed-rate terms of 10, 20 and 25 years. Compare these options if you want to shorten the term without dramatically increasing your monthly payment.

ARM to Fixed

Adjustable rate mortgages, or ARMs, offer lower introductory rates and can be attractive for buyers who don’t expect to finance a property for the long haul. Most ARM loans begin with fixed rates, which are in place for a period of time ranging between three to 10 years. After this fixed period, the interest rate can vary on an annual or semi-annual basis.

Refinancing an ARM or a hybrid takes the uncertainty out of future mortgage payments. ARMs can offer lower, “teaser” rates compared to fixed-rate products, but because they can and will change at some point, if fixed rates are low and the home owner intends to own the property for the foreseeable future, it is likely a wise decision to refinance.

When NOT to Refinance

Cashing Out

One of the worst reasons to refinance a mortgage is to pull out cash. Refinancing an existing mortgage requires closing costs, but borrowers typically pay for these with the equity in their home, while simultaneously putting some extra cash in the bank or using it for other purposes.

Refinancing for the sole reason of pulling out cash is a bad, expensive idea. If you are in need of extra cash, a home equity line of credit or second mortgage may be a better option as they are much less expensive overall.

Wasted Interest

Let’s review the $200,000 30-year loan at 3.50% from above. After five years, the amount of interest paid is $33,279. At first glance it seems like a good idea to refinance and lower the monthly payments if possible. By refinancing into another 30-year loan, you’ve lost that $33,279 and extended your loan back to its original loan term, effectively changing your original 30-year loan into a 35-year mortgage!

Important Note: In some instances, particularly those that involve low mortgage interest rates and a long-term outlook, a refinance into a longer-term loan could be an advanced and strategic financial planning decision. This is not intended to be financial advice – however, each situation is unique and you should discuss this option with your advisor in detail.

While the majority of homeowners will consider interest rate as the guiding light towards the appropriateness of a refinance, there are many other considerations worth evaluating. Take your time and consider both the short term and longer-term impacts of your refinance decision.

7 striking similarities between Mortgage & Home Air Conditioner Shopping

If you have ever shopped for a new home air conditioner, you know how time consuming and confusing the process can be. Likewise, if you have recently shopped for a mortgage, you probably spent a good deal of time learning and considering your options.

On the surface, these industries are far and apart. After all, a mortgage is a financial product and air conditioners are physical products used to increase home comfort.  Despite the difference between industries, the sales environment and process of shopping for these two products is strikingly similar.

AC vs. MTG

Here is a toe-to-toe comparison detailing 7 similarities.

Mortgage interest rate shopping?

If you are looking for a new purchase mortgage or refinance mortgage, I suggest using MortgageCS. Getting answers from live verified loan officers and saving up to 90% of the time needed to shop – ALL while protecting your personal information – is a great way to take the sting out of the process.

If you are in the market for a new air conditioner, I have to let you know that we haven’t yet created AirConditionerCS – but we’ll be sure to keep you posted!

On a serious note, we have created a few tips on how to get the best results when mortgage shopping. Check out this recent post.

Common reasons you aren’t shopping for a mortgage – and how to fix it

“I can’t wait to shop for my mortgage!”

(Said no one, ever.)

When it comes to the tasks associated with buying a home, shopping for a mortgage may win the award for least desirable action. Let’s look at the reasons why some people don’t shop for a mortgage loan and provide simple solutions to improve outcomes all around.

After all, the financial impact of a mortgage loan will last years, perhaps decades, beyond the few days required to identify the best mortgage lender.

You didn’t realize you could shop

If you fall into this category – we’ll save you the embarrassment and get it over with quickly.  You can always shop for a mortgage – even if your Realtor or Financial Advisor has an “in-house” lender or mortgage broker. Generally speaking, any “in-house” lender or mortgage broker is paying (one way or another) for this privilege. This can, and likely does, have an impact on the loan terms offered – ultimately delivering a less than desirable result for you in the form of inflated fees or interest rates.

How to fix it: Great news!  You just did. You now know you can shop – so do it!  You are in charge of your own financial well being and any “pain,” perceived or otherwise, that may come with shopping for a mortgage will be short-lived compared to the consequences of overpaying on a mortgage for 30 years.

MortgageCS is an unbiased mortgage resource, so we can’t help but suggest you use MortgageCS.com to ensure that shopping is efficient and hassle free.  There is no other place where you can easily company mortgage options without a bombardment of phone calls and undesirable credit report inquiries.

You believe all mortgage companies offer the same rates 

This one is just about “as a matter as fact” as it gets. When it comes to the rates offered by mortgage brokers and lenders, their operational structure does a good deal of the talking.  A few differences to look out for include:

  • Layers of management: Just about all mortgage companies earn revenue when they originate new loans.  Accordingly, a company with multiple layers of management will have more “mouths to feed” from each loan compared to a mortgage company with less management. More mouths to feed means they need to charge more on each loan.
  • Office location(s): When it comes to overhead expenses for a mortgage lender, just about nothing exceeds the combined expense of banking licenses and equipment for a physical location.  Not only does each physical location need to spend several thousand dollars each year to maintain their banking licenses in each state, but they also need to pay for the office equipment, fancy desks and signs, and all other expenses.

There are several other reasons why rates can vary between lenders, but rather than describe the depths and complexities of the secondary market, we hope you may take our word for it!

How to fix it: Again…you just did. You now know that different mortgage companies offer different rates and fees in order to support their operational structures and overhead expenses.  Accordingly, a rate that may seem “impossible” for one lender, may actually be provided by another lender on an everyday basis. 

You are afraid to mortgage shop

Shopping for a mortgage involves all types of new terms, a market that changes at least once a day and pressure from all directions to meet your purchase agreement deadlines.  Factor in the pressure from a real estate agent telling you that the “only one” that can close on time is their mortgage professional and the fact that we, as humans, don’t like to tell people “no”, and you have an environment which can quickly become overwhelming and scary.

How to fix it: Remember that you are in charge of your own financial future.  Real estate agents work hard to ensure the property sale transaction goes smoothly- but they are not compensated one way or another based on the terms on your new mortgage loan (and they don’t need to make the payment either).

While many mortgage originators stationed inside a Realtor’s office may offer ultra-competitive rates and may have a great reputation for getting to the closing table on time, don’t forget Reason 1 or 2 from above. 

About Mortgage Prequalifications

Also know that a pre-qualification doesn’t require that you continue with a particular mortgage lender. Up until the time when you are required to obtain a loan commitment, you have the option of shopping and searching for the loan terms which best suit your financial goals going forward.