Understanding and Comparing Closing Costs

Too many people borrowers make the mistake of shopping solely on the basis of interest rate, and don’t pay enough attention to the closing costs. On the surface, this approach makes the most sense since interest costs dwarf closing costs. However, while many lenders might offer similar interest rates (because such rates come from the markets, and are hence relatively uniform), they might differ dramatically on closing costs.

Closing costs can be categorized in accordance with a variety of parameters. Some experts like to divide costs into fees paid directly to the lender, fees ordered by lenders but paid to third parties, fees paid directly to third parties, and miscellaneous settlement costs. I’ve also seen fees broken out into additional categories, such as pre-paid insurance/taxes and title/attorney fees. While it’s justifiable to segment fees into as many categories as you feel comfortable dealing with, personally I think it’s reasonable to distinguish only between lender fees and non-lender fees, especially when initially shopping for a lender.

It can be tempting to make a blanket comparison between multiple lenders using the total settlement costs listed on the good faith estimate. However, more than half of these costs are probably estimated non-lender costs, and the lender could deliberately underestimate these costs to increase his appeal. Thus, it makes sense to really scrutinize lender costs, rather than third-party costs, when selecting a lender.

Which costs fall into the category of lender costs? The biggest fees are the origination fee and discount points, which are paid up-front for a lower interest rate. While discount points correspond to the interest rate and may be difficult to negotiate, the origination fee is based on the discretion of the lender/loan officer and can hence be negotiated. The same can be said for processing, underwriting, and application fees. All of these fees should be guaranteed by the lender upfront, in absolute Dollar terms if possible. Don’t worry about comparing individual line items between lenders, since these are often meaningless; you should focus instead on total lender fees.

Non-lender fees include appraisal, credit report, pre-paid insurance/taxes, pre-paid interest, legal fees, title fees, recording fees, inspection fees, etc. Some of these fees are ordered by the lender, and thus, should be guaranteed in writing. Fees that are paid directly to third parties can naturally be negotiated directly with the third party. Government fees are usually fixed, and hence not worth fretting over.

Negotiating closing costs have always been a frustrating part of the mortgage experience because it’s difficult to know what to pay. While interest rate information is published, closing costs are not. There are a handful of lenders that guarantee their dollar fees, but most are internet-based, which can add another factor into the selection process. Perhaps more useful are informative – rather than commercial – websites: “Closing.com, a site that can create instant closing-cost estimates as would-be borrowers search for the best or least expensive real estate service providers, has a vendor database of nearly 150,000 firms in 14 categories. And fairmortgage.org has dozens of lending organizations that promise to offer safe mortgages at fair prices.” Both sites offer confirmed prices for local lenders, customized for the type of home you are buying. Looks like negotiating closing costs just got a whole lot easier.