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Archive for the ‘Closing Costs’ Category

When purchasing a home, you not only need money for a down payment, but also for closing costs as well. Closing costs are the transaction related costs to purchasing a home. Generally speaking, closing costs run about 2% of your purchase price.

When applying for a mortgage, the lender is required by law to give you what is known as a Good Faith Estimate within three business days. The GFE is supposed to list out all of your expected closing costs so that there are no surprises at closing. Unfortunately, many lenders often produce very inaccurate GFE’s only to give their customers the smack down at closing when it is too late to back out. They are able to do this because most consumers focus too much on the interest rate and not the fees that go along with that interest rate. Additionally, closing costs can be very confusing because many of the fees are not controlled by the lender and it is really easy to low ball the GFE. Many consumers focus on the bottom-line or total estimated closing costs. This the incorrect way to compare closing costs because the bottom-line is not totally controlled by the lender.

Closing costs can be broken down into three main sections.

Lender Fees: These are the fees that lenders charge to process your loan. Lender fees generally consist of items such as appraisal, underwriting, processing, and administrative fees. It doesn’t really matter what these fees are called individually, but what the total of the fees are. If you are paying points, these would be listed under this section as well. If you are comparing mortgages from two different lenders, these are the only fees that you can use since all other fees will be the same regardless of who handles your mortgage.

Prepaid Items: These are items related to your mortgage that the lender requires you to pay in advance at closing. Typically, prepaid items consist of interest prorated from the day you close till the end of the month and property tax escrows. The amount of prepaid interest depends on the day you close and the amount of property tax escrow depends on when taxes are due in your area.

Title & Government Fees: Traditionally, the title company is chosen by the seller on a purchase. Therefore, the lender does not control the title company fees. However, an experienced loan officer should be able to reasonably estimate typical title company fees in your area. Title company fees consist of the charges to coordinate the closing and to provide title insurance. Also, any taxes or government recording fees will also be in this section. If you are using an attorney, their fees will also be in this section as well.

All of these costs add up to closing costs. When comparing mortgages, it is important that you understand these ancillary costs and you are prepared to cover them. Your loan officer should be able to explain each and every charge that you are expected to incur when closing your loan – even the charges that are unrelated to the lender.

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pinochio.jpgGovernments have a way of doing things to the lowest common denominator. Unfortunately, the mortgage industry bears the brunt of a lot of legislation that when looked at objectively, makes zero sense to logical people. One of my favorites is the Truth in Lending (TIL) disclosure that mortgage lenders must provide consumers when applying for a mortgage.

The TIL is a disclosure that lenders use to calculate what is known as the annual percentage rate (APR). The APR is an interest rate that is recalculated after all of the costs associated with obtaining the loan are included. The theory behind providing an APR is that the federal government believes that consumers aren’t savvy enough to figure out that on a $300,000 loan a rate of 6% with no costs (loan A) is actually better than a rate of 5.875% with $5000 (loan B) in costs because most consumers focus too much on the interest rate and not the total cost of the loan. The APR calculation attempts to rectify this situation by providing the real rate with all of the costs. In our example, the APR on loan A is just 6% because there are no costs to be included. The APR on loan B is 6.02%. Therefore, when you consider the costs, loan A is the better deal despite having a higher interest rate because the fees are substantially lower. This is why federal law requires that mortgage lenders also provide an APR in advertising. When you see an ad for an interest rate, you will also see next to the rate quote an APR.

While the APR can be an effective tool to evaluate mortgage packages, there are some serious flaws that make it practically worthless in the real world. The flaws are as follows:

Time Horizon: The first flaw is that the calculation is done over the life of the loan which is typically 30 years. The average home owners lives in their home seven years. By shortening the time horizon for the loan, you significantly reduce the benefit of paying a large amount of fees for a slightly lower interest rate.

Consistency of Costs: There isn’t a consistent set of fees that are included in the APR calculation. This causes obvious problems. Some lenders include title fees, some lenders don’t. Some lenders include credit report and appraisal fees, some lenders don’t, etc As a result, unless you can compare exact fees across lenders, there really is no way to know if you are getting an accurate number.

Can’t predict the future: The biggest flaw with APR is that it only works on fixed rate mortgages. The calculation is even more useless if you want an adjustable rate mortgage (ARM). The reason is simple. No one knows what your rate will be in the future when you get an ARM making the calculation subject to worthless assumptions pulled from thin air. For example, if you get a 5/1 ARM. Your rate after five years is determined by an index and a margin. Unless you have a crystal ball, there is no way to know what the applicable index will be in five years. In their wisdom, the government says lenders are supposed to use the current index and margin as the rate assumption going out after the five year period is up. Need I really explain more as to why you can’t use TODAY’s rate as the rate assumption five years from now? Good God man, what are these people thinking?

Let’s demonstrate what happens when you consider the flaws. Loan A has a rate of 6% and $1000 in fees. Loan B has a 5.75% and $4000 in fees. Assuming a 30 year amortization, the APR on loan A is 6.031% and the APR on loan B is 5.875%. Seems like Loan B is the way to go. But wait, most people don’t live in their home 30 years. Let’s assume you are only going to live in the home five years as with most first time home buyers. Loan A’s APR is now only 6.138% while Loan B is now 6.301%. Clearly, Loan A is the best loan unless you are going to live in the property for a substantial amout of time. Of course, this only shows the first problem of time, but the other issues of consistency of fees and ARMs should be self evident.

Nevertheless, I will say that APR is a good starting point when evaluating mortgage loans, but it should be taken with a grain of salt. As always, if you have any questions about APRs or mortgages in general, don’t hesitate to give me a call.

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Okay, so you heard Suze Orman say you should shop for your mortgage. Great. What Miss Suze failed to tell you is that shopping for a mortgage is very different from shopping to buy a plasma screen TV or a new car. In fact, it is unlike anything you have ever experienced. Unfortunately, most consumers don’t know this and wind up getting themselves in trouble.

Before shopping for a mortgage, here are the main things you need to know and understand CLEARLY:

Fluid Pricing: Mortgage prices are fluid. In other words, they change every single day. Sometimes they change several times per day. Without getting into boring financial minutae, you just need to know that mortgage interest rates are determined how Wall Street is performing, particularly mortgage backed securities. As such, the interest rates you hear on Monday are worthless on Tuesday. This causes quite a problem for consumers and is often the hardest thing for them to understand. If you are comparing rate quotes you have to compare quotes from the same day! You cannot call Bank A on Monday and compare it to Bank B on Friday. It is not an apples to apples comparision. Worse yet, if Bank A gives you a great deal on Monday, it may not be there on Friday when you come back.

Loan Features & Structure: Another problem borrowers run into is comparing the appropriate loan features and structures. These items also determine your rate. A 5/1 ARM is going to have a different rate than a 30 year fixed. Does loan A require property tax escrows while loan B does not? One loan may require PMI while the other may not. Better yet, one loan requires a down payment while the other is 100% financing. Maybe one loan is full doc while the other is stated income? One loan guaratees your rate for sixty days while the other is only for 15 days.

Because there are so many options and ways to structure your loan, you really have to know the specifics to really be able to compare apples to apples. Unfortunately, unless the loan officer gives you information overload, the odds are you are not going to know all the details being considered about your situation. The end result is that it is almost impossible for you to truly shop your loan based on features and loan structures beyond the generic categorizations of mortgage types.

Closing Costs and Fees: The other side of the equation when shopping for mortgages are the costs. You would be amazed at how many consumers believe a 5.875% interest rate with $4000 in closing costs is a better deal than a 6% interest rate with no closing costs.  Getting accurate closing costs estimates is paramount.

Your loan officer should provide you with a clear and accurate GFE explaining your closing costs. Too often consumers simply pick the one that is lower. It is not a question of lower, it is a question of ACCURACY. Would you rather the loan officer tell you upfront what to expect or stick it to you at the closing or say “ooopps, I didn’t know about the $2000 transfer tax?” A large percentage of closing fees are not even related to the lender.  Often times, inexperience or shady lenders leave these fees off of their estimates to make the costs look lower.

Intangible Items: Buying a home is the largest purchase most people will ever make. The process is very complex, legal contracts are involved, emotions are running high, money will be put at risk, and the process can be overwhelming. YOU ARE NOT BUYING A TELEVISION. As such, you need to treat the purchase with respect and ensure you are working with professional. It amazes me that consumers would rather put such an important purchase in the hands of some random guy in some call center making $10 bucks an hour rather than deal with a seasoned local PROFESSIONAL.  Simply picking the lowest rate/costs quote is typically the biggest mistake rate shoppers make and they wind up paying for it through either poor service, missed closings, and worse, lost earnest money. Do not make a decision without looking at the big picture.  Put another way, would you pay $100 bucks to a lawyer with a 100% win record or $75 bucks to a lawyer who might win? Just food for thought.

SHOP FOR A LOAN OFFICER, NOT A MORTGAGE: Given the above, it should be obvious that shopping mortgages is a misnonmer. It really can’t be done effectively. Every mortgage is unique and tailored to your particular situation. The biggest tip in shopping for a mortgage is to shop for a loan officer, not the mortgage. I know this concept may need to marinate for awhile, but this is truly the best way to shop mortgages. The individual loan officer is the one who will make or break your experience. If you find a good loan officer, all of the other item such as rate, costs, and expertise in guiding you on this large purchase should fall in to place.

You shop for a loan officer with the same approach you would shop for an other professional. Get referrals from friends, family, and co-workers. Ask for references from past clients. Ask the loan officer abou this or her experience, background, and expertise. Is the loan officer upfront and transparent with regards to how they are pricing your mortgage?  I will write more on the questions you need to ask every loan officer, so look for the article.

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