September 2008
In this Issue
Untangling the Sources of Mortgage Closing Costs
HECM Program: Coming Into Its Own
Energy Efficiency Inside and Out
Every Picture Tells a Story: Data Images of Subsidized Households
In the next issue of ResearchWorks
Untangling the Sources of Mortgage Closing Costs
The myriad mortgage loan costs and fees encountered at a typical real estate closing leave many homebuyers feeling overwhelmed. To help borrowers more easily compare loan costs, Congress passed the Real Estate Settlement Procedures Act of 1974 (RESPA) to increase competition and transparency in real estate lending. Until now, HUD, the cabinet-level agency responsible for enforcing RESPA, has been unable to measure how effectively the Act has met these goals. A new study commissioned by the Office of Policy Development and Research uses 7,560 fixed-rate, 30-year mortgages insured by the Federal Housing Administration, fee data from HUD-1 settlement statements, and census data to examine homebuyers' experiences. The resulting report, A Study of Closing Costs for FHA Mortgages, provides insight into the fees and closing cost variations paid to lenders and mortgage brokers, real estate agents, and title companies.
Mortgage Brokers Charge a Premium
Fees paid to mortgage lenders and brokers add significantly to homebuying costs, with total origination and closing costs averaging $3,400, or 1.3 times the average $2,550 downpayment made by homeowners. Wide variation in costs exists between lender types (brokers and direct lenders, such as banks and other depository institutions), with brokered loan fees exceeding direct lender loan fees by $300 to $425.
Although loan fees were legitimately tied to lender risks — as measured by variables such as loan amount, property value, and the borrower’s credit score — price discrimination has been known to occur. Loan fees are highly correlated to race and education characteristics, with African-American and Latino borrowers paying an average of $415 and $365 more, respectively, than other borrowers.
Being more educated, or at least appearing to be more educated, gave homebuyers an edge during loan closing. On average, homebuyers in census tracts that have more college-educated adults paid $1,100 less than those buying in census tracts with no college-educated adults.
Loan Complexity Adds Cost
More complicated loan transactions result in higher total loan costs for borrowers. Loans containing yield-spread premiums (YSP), discount points, and seller contributions to closing costs elevate total borrower costs.
In a competitive market, borrowers expect clear tradeoffs when choosing between loan transactions, which may mean paying more upfront cash for lower interest rates or accepting a loan with a higher interest rate in return for lower upfront costs. However, the tradeoffs may be harder than expected for consumers to calculate. Research shows that borrowers saved only $20 in upfront cash for each $100 paid in YSP. Mortgage-brokered loans benefited the least, saving only $7 per $100 in YSP. Discount points followed a similar pattern, with borrowers of brokered loans seeing no savings. In comparison, bank customers paying points received $65 for every $100 in discount points paid. Borrowers also received less than a 100-percent return when sellers contributed to closing costs. For every $100 a seller paid, the borrower got an average benefit of only $50, with borrowers from banks and other depositories getting $70 and brokered loans benefiting by only $40.
"No-cost" loans appear to offer the most competitive terms for borrowers, allowing consumers to compare loans based on interest rate without having to determine the best tradeoff of upfront costs versus rates. Although no-cost loans may not be the least expensive option when considering the higher interest rate, borrowers with no-cost loans paid $1,200 less for loan origination services than borrowers who paid some lender/broker fees in cash. The no-cost loan market also appeared more competitive, in that costs showed little or no relation to borrower education or race.
Title and Real Estate Agent Fees Add Costs
Title and real estate agent fees also added considerable costs to homebuying. Title charges averaged $1,200 per loan, with higher title fees charged when fees to lenders and real estate agents were high, even though these costs have little correlation with each other. The large disparities in title fees, along with strong correspondence to borrower race and education, suggest that title services are neither competitive nor transparent.
Most real estate agent fees (76 percent) were equal to 6 percent or less of house value, with the remaining 24 percent charging a higher rate. Agent fees were most closely linked to house value and downpayment (i.e., fees are less on home loans with lower down-payments) with no correlation to race and little correlation to education.
Improving Disclosure to Borrowers
Although this study focuses on data analysis, it is unambiguous in calling for better and clearer consumer information. Wide variations in costs between services and lenders, as well as price discrimination, indicate a less-than-competitive market. Better and more readily understandable disclosures would make it easier for borrowers to compare and shop for the lowest cost mortgage, while also eliminating price discrimination based on race and education. Continued monitoring of closing costs, title services, and other real estate services will also be necessary to achieve a more transparent and competitive residential mortgage market.
You can order a printed copy of A Study of Closing Costs for FHA Mortgages for a nominal fee or download a copy at no cost from the HUD USER website at www.huduser.gov/publications/hsgfin/fha_closing_cost.html.
