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.

Settlement costs can be divided into the following categories:

1. Fees paid to lender

2. Lender-controlled 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.

Shoppers should ask for dollar fees 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. These include Eloan.com, Indymac.com, HomeLoanCenter.com, Mortgage.com, Mortgage.etrade.com, and Countrywide.com. If they can do it, any lender can, and they will if shoppers demand it.

Lender-controlled fees are paid to third parties for services ordered by the lender. These include the costs of appraisals, credit reports and (when needed) pest inspections. Lenders know the prices of these services and can easily guarantee them in addition to their own fees. Countrywide.com, mortgage.com, and mortgage.etrade.com, include appraisals and credit reports in their guarantees.

Other fees paid to third parties are not controlled by, and may not be known by the lender. The most important of these are title-related services and settlement services. If you are in an area in which it can pay to shop for them, you can do it after selecting the lender. Mortgage.com includes third party fees in its guarantee except for charges of governments.

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.

In sum, in shopping lenders, you want the total of points including origination fee if any, dollar fees, and lender-controlled fees paid to third parties. Ask if they will guarantee all fees except points in writing.

Shopping Strategy: 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 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.

Furthermore, even if a determined borrower succeeds in bludgeoning the lender into making a change, the determined lender can get it back somewhere else. The costs shown on the GFE are “estimates”, and can be different at closing than they were the day before closing. This is a game the borrower can’t win.

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 new rules regarding settlement costs that have been proposed by HUD, which could well be enacted in 2003. Under these rules, borrowers will be able to obtain one binding price covering all settlement costs from lenders electing this option.

Until that happens, however, borrowers can’t use this strategy effectively. Lenders will not commit to any figures on total settlement costs that they might quote to shoppers. The reason is that today, lenders have complete knowledge and control only over their own charges. They don’t control and don’t necessarily know all third party charges, which is why the GFE is an “Estimate”.

Suppose, for example, you are deciding between 7% 30-year fixed-rate mortgages offered by two lenders. Lender A quotes total settlement costs of $4,000 compared to $4,200 for lender B. Lender A looks like the better deal.

Closer inspection reveals, however, that A’s own fees are $2,000 and A has estimated other costs of $2,000. B’s own fees, in contrast, are $1,900 and B has estimated other costs at $2,300. The correct choice is B because B has the lower lender fees, which lenders can guarantee. The other costs are estimates. While we don’t know which is closer to the mark, we do know that the actual figure will almost certainly not be affected by whether the shopper selects A or B.

Since lenders being shopped for total settlement costs have an incentive to err on the low side, we can guess that B’s estimate probably will be closer to the mark. Whether A deliberately low-balled to get the business, or made a “good faith” mistake there is no way to know.

The bottom line is that until HUD changes the rules, shoppers who want to control their settlement costs should focus on lender fees only.

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. Mortgage brokers can also help borrowers find third party services at competitive prices.

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.

Updated February 15, 2003

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