Mortgage costs continue to confuse borrowers
Many buyers focus on just one of a wide range of mortgage costs when they're shopping for a home loan. They search for the best mortgage rates when comparing quotes from lenders.
Mortgage Closing Costs
And that's smart. Using a mortgage payment calculator and some basic math, one can see that someone taking a $180,000, 3.5% APR loan on a $200K home is likely to pay just over $110,000 in interest over the lifetime of a 30-year fixed-rate mortgage. Anything that can be shaved off that is going to be welcome.
However, just because interest is by far the biggest of the various mortgage costs, that doesn't mean one should ignore the others. Closing costs vary widely between mortgage lenders and loan programs. Typically they run from two to four percent of the home's purchase price. In the example above, that would be $4,000 to $10,000.
Consumers who compare quotes from several lenders may be able to place themselves at the lower end of that range. There's absolutely no reason for a buyer not to contact competing lenders and choose the loan with the lowest overall costs.
There's a widespread belief that all closing costs are deductible when filing federal taxes. That's untrue for most, but there are exceptions -- and they can be big ones.
The IRS says the following may be deducted by those who itemize their deductions:
- Any property taxes paid by the buyer at closing, although there are special rules for cooperatives.
- Prepaid mortgage insurance premiums (MIPs).
- Mortgage origination fee. That's is usually expressed as a percentage of the home loan amount, for example one point.
- Discount points used to "buy down" a mortgage rate. These are paid to obtain a lower interest rate, not to originate the loan. These have to be pro-rated and deducted during the life of the mortgage. If you paid $3,000 in discount points to reduce the rate of a 30-year home loan, you'd be able to deduct 1/30th of the points, or $100 per year. If you refinance your mortgage, you'll be allowed to deduct any discount points that have not yet been deducted.
- Mortgage interest paid during the year.
To deduct any of these costs, you have to itemize your deductions on a Schedule A. If you take the standard deduction, you cannot deduct closing costs or interest expense.
Closing and Mortgage Costs
Most closing costs are related to the mortgage or are associated with home ownership.
- Appraisal fee. Paid to the professional who assesses the value of the property.
- Attorney or title company fees. This is for escrow services when you sign the documents and complete a property purchase.
- Credit report fee. Covers the costs of checking your credit rating.
- Discount points. These are paid to get a lower mortgage rate.
- Impounds. These are pre-paid property taxes and homeowners insurance. They are not a lender fee but are simply costs related to owning a home, If you borrow more than 80 percent of the purchase price, most lenders require impounds. They prorate these amounts and add them to the monthly mortgage payment. Then the lender pays your insurance premiums and taxes as they come due.
- Inspection fees. It's recommended that buyers have a professional inspection to make sure the home is safe and livable.
- Loan origination fee. Charged by the lender for processing the mortgage application. It's usually defines as a percentage of the loan amount (in this case it's an "origination point" and not a "discount point") but it may also be a flat fee.
- Pest inspection fee. This determines if the property has termites or any other infestation.
- Recording fee. Charged by the city or county for recording the ownership change for the property and the lender's lien against it.
- Title insurance fee. There are two policies – the buyer's and the lender's. The first one protects the buyer in the event that the title is not clear. The second protects the lender's interest. If you finance a home purchase, the lender will almost certainly require that you purchase a lender's policy.
- Title search fees. A search is intended to uncover any encumbrances on the title, such as unpaid mortgages or tax liens.
- Underwriting, processing, document preparation, courier fee, and more. These may be charged by the lender as separate items but are commonly wrapped into the origination. In the industry, these are called "junk fees" and they are absolutely negotiable.
Good Faith Estimates
Good faith estimates (GFEs) protect buyers by disclosing home loan costs when they apply for a mortgage. Lenders must provide a GFE, which lays out the basic terms and expected costs of the loan, within three working days of receiving a mortgage application. Many are willing to provide one before you actually apply, which makes shopping for your mortgage easier.
Other lenders do not issue GFEs to loan shoppers. Instead, they provide a "worksheet" or "scenario." There is nothing wrong with this, but you should be aware that only an actual GFE provides certain protections.
Lenders must issue a new GFEs any time there is a "material" change in your application (for example, you applied for a 30-year fixed loan but then switched to a 5/1 ARM). Your actual closing costs must essentially match the final GFE. Closing costs are divided into three categories – those which cannot vary from what was disclosed at all (most lender fees fall in this one), those that can come in higher but within certain limits (most of these are services from lender-selected providers), and those that can change by any amount (those are mostly costs from providers chosen by the borrower).
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