New Rules Clarify Closing Costs

For anyone who has done some preliminary research into obtaining a mortgage, you have probably come across the “good faith estimate [GFE].” Anyone who has actually gone through the process of obtaining a mortgage, meanwhile, knows there isn’t a more ironic concept than GFE, and is probably chuckling right now.

The GFE was originally intended to help consumers shopping for mortgages, by giving them an upfront estimate of what they could expect to pay for a mortgage issues by a given lender. Over the years, however, the GFE has been abused by not a small number of lenders and turned into a deceptive marketing tool. While some lenders made a sincere effort to accurately estimate closing costs for potential borrowers, anecdotal evidence suggests that the majority realized that this would make them less competitive, since their peers were quoting ridiculously low fees, in the secure knowledge that there would be no recourse (legal or otherwise) for the borrower, if they raised the fees at closing time. Basically, the GFE became yet another variation on the “bait and switch” scheme.

Congress’s latest effort to rectify this contradiction will certainly make it much more difficult for lenders to operate in this way. As part of the Real Estate Settlement Procedures Act, which went into effect Jan. 1, lenders will now be contractually obligated to offer a good faith estimate within 72 hours of receiving the borrower’s application. In addition, the estimate must really be in good faith, and lenders are prohibited from tampering with certain fees later on. The table below, courtesy of USA Today, contains an excellent summary of these restrictions.

As part of the legislation, lenders will furnish the GFE using a standardized form, so that borrowers can easily shop around and compare loans from different lenders.

The first page states how long the information is valid for, along with a summary of the loan characteristics — such as the initial loan amount, the loan term, the initial interest rate, whether the rate can rise and if the loan has a prepayment penalty or a balloon payment. It also discloses whether an escrow account is required for the loan and an estimate of settlement charges. The second page breaks down origination costs and settlement charges. The third page explains which charges can and which can’t increase at the time of settlement, as well as which ones can only increase by a maximum 10%. The bottom of the third page serves as a worksheet for borrowers to compare options.

This table should make it easier for borrowers to compare different types of loans, as well as to determine if lenders are compensating for lower settlement costs with a higher interest rate, and vice versa.

Thanks to the amended Truth in Lending Act, which went into effect over the summer, borrowers must wait at least seven days after receiving this GFE before they can close on the loan. “Additionally, if the final APR rate is off by more than .125% from the good-faith estimate, then borrowers MUST wait another three days before closing.” Of course, if the borrower locks the rate with the lender, then a change in the final rate (unless previously warned by the lender in writing) would constitute fraud, and the borrower could petition for redress.

At the same time, there are still gaps in the process that aren’t addressed by other law. First of all, the GFE still doesn’t make it clear to lenders that they can shop around for the best deals on specific line items, such as title insurance, home inspection, etc. Many borrowers will probably still be tempted to simply compare the overall costs when choosing between two lenders, rather than such individual line items. In addition, the GFE forms don’t include an estimate of the borrower’s expected monthly payment under the parameters of the loan, potentially introducing a loophole for lenders to tinker with the numbers. Finally, it doesn’t specify what funds borrowers will need at closing.

Overall, though, it represents a vast improvement over the old system, and borrowers can now rest assured that the final costs won’t differ much from the initial estimates.