How to Shop Settlement Costs

March 5, 1999, Rewritten February 15, 2003, revised March 22, 2006, November 10, 2006, June 12, 2007

Settlement costs are one of the most confusing and irritating features of home mortgages in the US. Confusion arises out of the many different types of costs involved, which can vary from state to state and also from lender to lender. Confusion also arises over how to deal with them. Are some settlement costs negotiable, and if so which? Should they be shopped, and if so, how? This article deals with these questions.

It makes a difference whether the shopper is dealing with a lender or with a mortgage broker. I’ll deal with the lender case first.

Shopping Settlement Costs With a Lender

Settlement costs can be divided into the following categories:

1. Fees paid to lender

2. Lender-guaranteed fees paid to third parties

3. Other fees paid to third parties

4. Other settlement costs

Fees paid to lender (henceforth “lender fees”) should be the shopper’s major focus. Lender fees consist of points and dollar fees.

Points are an upfront charge expressed as a percent of the loan amount. An origination fee is the same except it is not related to the interest rate as points are.

Dollar fees are those specified in dollars. Some of the common fees are for: processing, tax service, flood certification, underwriting, wire transfer, document preparation, courier, and lender inspection. But from a shopping perspective, what they are called doesn’t matter, and whether they are justified doesn’t matter. All that matters is their sum total.

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.

Lender-guaranteed fees are those paid to third parties for services ordered by the lender, where the amount of the charge is guaranteed by the lender. The fees falling within this category vary from lender to lender, and may vary for different types of transactions.

Most lenders don't guarantee any third party fees, and one lender, ABN Amro, guarantees them all except for charges of governments. Amerisave guarantees some fees, including title insurance on refinances but not on purchase transactions. Obviously, the larger the portion of third party fees that is guaranteed by the lender, the greater the confidence that borrowers can have in the total of such fees.

Other fees paid to third parties are not guaranteed by the lender. The lender must estimate them for inclusion in the Good Faith Estimate, however. The borrower's major concern is whether or not the lender is low-balling these fees to make his deal look better. On-line lenders who show all settlement costs are very unlikely to low-ball.

Other settlement costs 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. The amount is based on a HUD formula.

*Hazard insurance is your homeowner’s policy, which you purchase from a carrier of your choice.

Shopping Strategy: The borrower's major focus should be lender fees, because these can be pinned down.

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 lender charges afterwards. Typically they do this after they receive a Good Faith Estimate (GFE), which itemizes all the settlement costs including all lender charges.

But challenging individual cost items is not an effective way to control lender fees. The typical borrower has 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.

Shoppers should ask for the total of dollar fees at the very beginning, 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.

Many retail lenders guarantee their dollar fees now, including the four Upfront Mortgage Lenders: Eloan, Amerisave, National Mortgage Alliance, and Betterchoiceloans. If they can do it, any lender can, and they will if shoppers demand it.

Some shoppers adopt a different strategy, which seems to make a lot of sense. They reason that what 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 rules regarding settlement costs that were proposed by HUD in 2002. Under these rules, borrowers would have been able to obtain one binding price covering all settlement costs from lenders electing this option. But the proposed rules were withdrawn in 2004.

The problem with this strategy is that, unless guaranteed by the lender, third party charges are estimates and some estimates are not made in good faith. Some lenders low-ball them to hook the borrower. The risk in shopping total fees is probably small, however, if the shopper sticks to lenders who disclose their estimates on their web sites.

The bottom line is that until HUD changes the rules, shoppers who want to control their settlement costs should focus on lender fees only. The alternative strategy of shopping total settlement costs is likely to work well if the borrower shops only on-line.

Shopping Settlement Costs With a Mortgage Broker

If the shopper is dealing with a mortgage broker rather than a lender, the process is both more complicated and simpler. It is more complicated in the sense that there is one more significant fee to consider: the broker’s. 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 problems for their 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. Upfront Mortgage Brokers explicitly guarantee lender fees once the lender has been identified. See UMBs Now Guarantee Lender Fees.

The upshot is that shoppers who deal with a mortgage broker can shift their focus from shopping settlement costs to negotiating with the broker. I have urged shoppers on many occasions to approach the broker as a service provider who gets paid a fee that is negotiated at the outset. This is in contrast to the usual procedure of adding the broker’s fee to the points charged by the lender.

Just make sure that the broker fee includes any payment to the broker from the lender. For example, if you agree on a fee of $3,000 and the broker gets $1,500 from the lender, your payment should be the difference of $1,500. Upfront Mortgage Brokers operate this way as a matter of course, but many other brokers are willing to do business this way with educated borrowers who understand the value of broker services.