The Cost of a Mortgage: Going Beyond the Lender Letter

This article first appeared in Mortgage Orb.

For lenders and loan officers, it is often easy to forget how overwhelming or mysterious the homebuying process is for buyers. Particular aspects of the process that professionals take for granted may catch potential borrowers off guard.

For example, a closing might fall through because the buyer decided to buy a motorcycle between the purchase contract and the closing table. Or perhaps the buyer has experienced an interruption in income, such as a job loss. While the buyer may have thought they were in the clear because they had been approved for their loan, they didn’t realize that a change in debt or decrease in income put their pending mortgage in danger.

To improve the percentage of applications that make it to the finish line, lenders should be prepared to help educate borrowers that the mortgage process is more than just a down payment and the monthly mortgage payment. By helping explain how the costs of purchasing a home can change based on various changes to the circumstances of the borrower or property, lenders can share their expertise and ensure prospective borrowers become satisfied homeowners.

This is critical, as borrowers need to know what is coming. They need to be sure they have enough money to take on the responsibilities of homeownership. Even if their debt-to-income ratio and credit scores look great on paper, there are many other costs to consider that can make the trip to closing easy or a minefield.

Common Borrower Misperceptions on Costs and Qualifications

Lenders have truly seen it all. Having guided borrowers through the homebuying process many times before, they have seen unexpected costs arise time and time again and can use their vast knowledge to help inform borrowers of what a mortgage truly requires. Let’s dig into some of the most common misperceptions on home purchase expenses lenders see:

Prequalified means preapproved

While prequalified and preapproved sound the same to many borrowers, lenders know there is a huge difference between the two. Home shoppers can get a prequalification letter by simply plugging their income and debt obligations into an online form. While it can give a good estimate of what a borrower could afford, the financial institution has not vetted any of the supporting documents.

On the other hand, preapproval is a much more thorough process where the lender has vetted a borrower’s financial situation and approved a loan up to a certain amount barring any major changes. Then, the only truly unknown is the property appraisal and the acceptability of the property if the buyers make a selection in a condominium project or Planned Unit Development (PUD). Sellers now nearly always prefer buyers with a preapproval letter since it indicates a vetted capability of purchasing a home.

Saving for the down payment is enough

Saving up for a down payment is a major accomplishment for many prospective homeowners, especially first-time homebuyers. With the average home price in the United States near $250,000, borrowers often need to save up nearly $10,000 to make a standard 3.5% to 5% down payment.

However, the down payment is not enough. Borrowers will typically also need to set aside an additional one to two percent of the borrowed amount for closing costs in addition to paying for the appraisal. Many lenders also want to see at least two months of mortgage payments in reserves.

The property for sale has no associated costs

While in an ideal world, there would be a clear title on a new home, many properties will have potential collection accounts, judgements or liens that may need to be settled. Additional property-related expenses can add to the pre-close cost of a loan. A few of the more common property-related expenses include the home inspection, oil tank search, radon testing and the structural report.

After the inspection of the property, the borrower and seller may need to negotiate who handles repairs that cause a house to be “out of code.” Commonly, there also are adjustments made for any items the seller might have prepaid, such as taxes, assessments or utilities for the property. For example, though its price is not mentioned upfront, the homebuyer might be responsible for repaying the cost of the heating fuel the seller has just bought for the house.

Once I get my disclosure, closing costs cannot change

While it is illegal for lenders to intentionally underestimate closing costs on the loan estimate, there are costs that can change between the initial disclosure and the closing table. This is one of the most confusing aspects of mortgage costs to many borrowers so lenders should be able to explain which costs can change, along with which ones cannot.

Interest rates that are not locked in may change at any time. Even if a rate is locked, changes to information on the application or the expiration of the lock period can still result in a change in rate.

For closing costs, there are two categories of fees that can potentially change. Certain costs are not controlled by the lender and can increase by any amount at any time. These include prepaid interest, property insurance premiums or initial escrow account deposits. Lenders also have no control over third-party services that are not required or that the borrower chooses that are not on a lender’s written list of approved providers. These are noted as services the consumer ‘Can Shop For.’

Other closing costs, when subtotaled, can increase by no more than 10%. These include recording fees and required services provided by approved vendors who are not officially affiliated with the lender. The remaining costs cannot change unless there is a material change to the mortgage application. These changes include selecting a new loan product, an unexpectedly high or low appraisal, credit changes due to new debt or the inability to document income.

PITI covers the entire monthly payment

Lenders often share PITI – principal, interest, taxes, insurance – with borrowers when determining the monthly payment. However, the “T” can become more complicated than estimating annual property taxes.

Depending on where the buyer is moving to or from, there may be taxes for moving counties or leaving the state. These are usually dependent on location, so it is important to be informed on the taxes in the area of the purchased property. For instance, if a borrower seeks to leave a high tax state such as New Jersey, they may be obligated to pay an “exit” tax (technically an advance payment on income tax from the sales proceeds) when they purchase a home in another state.

Borrowers also are sometimes surprised that their mortgage payment can change even with a fixed rate mortgage. This is because most local governments reassess property tax values annually, which can raise (or occasionally lower) the monthly payment.

One last thing to consider if selling a home and buying a new one is a capital gains tax. If a house is sold and a profit is made, money that is not used on a new property and exceeds certain capital allowances may face significant capital gains taxes.

For borrowers that are looking to buy either a condo or a house within a subdivision with a Homeowners Association (HOA), they should be aware that some HOAs require the annual dues to be included in the mortgage’s escrow. Regardless of how they are collected, these fees can potentially add several hundred dollars to the homeowners’ monthly responsibilities. Also, trash removal, road maintenance or even snow removal may be  often overlooked, seemingly minimal expenses many would not consider. These surprising fees might be minimal, but could cause the loss of a sale.

For lenders, these costs are a daily fact of life, and they are knowledgeable about what goes into the mortgage. However, buyers often do not know the unique circumstances that impact the fees and costs they will be responsible for. Lenders need to make sure their borrower is aware of what they are getting into to make sure there are no bumps in the road. In addition, lenders need to share programs and tools that help the borrower understand and plan for the cost of a mortgage.

Help Me Help You: Tools Lenders Can Use to Help Buyers

Lenders can take advantage of many tools that exist to help them better inform buyers and communicate effectively about any hidden or unexpected costs. The Consumer Financial Protection Bureau (CFPB) provides a Home Preparedness guide to help potential buyers prepare to shop and explore their options.

The CFPB also provides a Closing Disclosure and Loan Estimate explainer to help lenders provide borrowers with answers to questions they might not know off the top of their head. These also serve as a great third-party resource to help borrowers feel confident that they have all the right information.

The Home Loan Tool Kit also serves as a great resource for potential homebuyers. This package of worksheets and tools helps buyers review their credit, set a budget and save money in preparation for their purchase. Referring borrowers to this resource six months in advance of their expected purchase will ensure that they have ample time to educate themselves and start putting plans in place to prepare for their purchase.

The more tools a lender has in their arsenal to assist the buyer, the better.

Communication is Necessary

One of the biggest tools a lender can utilize is communication. Being transparent with what the borrower is up against should not be a scare tactic, rather, you should be a guide to help the borrower in the homebuying process to make sure they are confident in pursuing a life-altering purchase.

As the homebuying experts, it is the lender’s job to share their knowledge with buyers to make sure they are sufficiently educated about the true cost of the impending purchase.

There are so many factors not listed on the price tag, but with the right communication, borrowers can feel confident in knowing what to prepare for and how to handle any additional costs.

(Editor’s note: Information in this article is subject to change as the GSEs continue to update requirements.)

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