Settlement Costs - Part II

This part of the booklet provides an item-by-item discussion of possible settlement services that may be required and for which you may be charged. It also provides a sample of the HUD-1 Settlement Statement form, and worksheets which you may find handy for comparing costs from different service providers.

Sections A through I of the HUD-1 Settlement Statement contain information concerning the loan and parties to the settlement. Sections J and K contain a summary of all funds transferred between the borrower, seller, lender, and providers of settlement services. The bottom line in the left-hand column shows the net cash to be paid by the borrower, while the bottom line in the right-hand column shows the cash due the seller. Section L is a list of settlement charges that may be required and for which you may be charged. Blank lines are provided for any additional settlement charges.

You would add up the costs entered on the lines of Section L, and carry them forward to Sections J and K, in order to arrive at the net cash figures on the bottom lines of the left and right columns.

Use of This Form

1. Settlement services comparisons. As you shop for settlement services, you can use the Settlement Cost Worksheet as a guide, noting on it the different services required by different lenders and the different fees quoted by different service providers.

2. Disclosure of actual settlement costs. A copy of this form, or one with similar terminology, sequence and numbering of line items, must be filled out by the person conducting the settlement meeting. Your right to inspect the form one business day before settlement was discussed earlier in this booklet. The form will be completely filled in at the settlement meeting.

Specific Settlement Services

The following defines and discusses each specific settlement service. The numbers correspond to the items listed in Section L of the HUD-1 Settlement Statement form.

700. Sales/Broker's Commission. This is the total dollar amount of sales commission, usually paid by the seller. Fees are usually a percentage of the selling price of the home, and are intended to compensate brokers or sales agents for their services. Custom and/or the negotiated agreement between the seller and the broker determine the amount of the commission.

701-702. Division of Commission. If several brokers or sales agents work together to sell the home, the commission may be split among them. If they are paid from funds collected for settlement, this is shown on lines 701-702.

703. Commission Paid at Settlement. Sometimes the broker will retain the deposit against the sales price (earnest money) to apply towards the commission. In this case, line 703 will show only the remainder of the commission which will be paid at settlement.

800. Items Payable in Connection with Loan. These are the fees which lenders charge to process, approve and make the mortgage loan.

801. Loan Origination. This fee covers the lender's administrative costs in processing the loan. Often expressed as a percentage of the loan, the fee will vary among lenders and from locality to locality. Generally the buyer pays the fee unless another arrangement has been made with the seller and written into the sales contract.

802. Loan Discount. Often called "points", a loan discount is a one-time charge used to adjust the yield on the loan to what market conditions demand. It is used to offset constraints placed on the yield by State or Federal regulations. Each "point" is equal to one percent of the mortgage amount. For example, if a lender charges four points on a $60.000 loan this amounts to a charge of $2,400.

803. Appraisal Fee. This charge, which may vary significantly from transaction to transaction, pays for a statement of property value for the lender, made by an independent appraiser or by a member of the lender's staff. The lender needs to know if the value of the property is sufficient to secure the loan if you fail to repay the loan according to the provision of your mortgage contract, and the lender must foreclose and take title to the house. The appraiser inspects the house and the neighborhood, and considers sales prices of comparable houses and other factors in determining the value. The appraisal report may contain photos and other information of value to you. It will provide the factual data upon which the appraiser based the appraised value. The appraisal does not, however, give rights to the purchaser nor necessarily detect or discuss defects in the property or title to the property. While most reasonable lenders will furnish you a copy of the appraisal upon request, they are not required to do so unless State law covers this situation. Therefore, it is important that you reach an understanding with your lender if you wish to see the appraisal, preferably at the time of payment of the appraisal fee.

The appraisal fee may be Paid by either the buyer or the seller, as agreed in the sales contract In some cases this fee is included in the Mortgage Insurance Application Fee. See line 806.

804. Credit Report Fee. This fee covers the cost of the credit report, which shows how you have handled other credit transactions. The lender uses this report in conjunction with information you submitted with the application regarding your income, outstanding bills, and employment, to determine whether you are an acceptable credit risk and to help determine how much money to lend you.

Where you encounter credit reporting problems you have protections under the Fair Credit laws as summarized under "Home Buyer's Rights" in this booklet

805. Lender's Inspection Fee. This charge covers inspections, often of newly constructed housing made by personnel of the lending institution or an outside inspector. (Pest or other inspections made by companies other than the lender are discussed in connection with line 1302.)

806. Mortgage Insurance Application Fee. This fee covers processing the application for private mortgage insurance which may be required on certain loans. It may cover both the appraisal and application fee.

807. Assumption Fee. This fee is charged for processing papers for cases in which the buyer takes over the payments on the prior loan of the seller.

900. Items Required by Lender to Be Paid in Advance. You may be required to prepay certain items, such as interest mortgage insurance premium and hazard insurance premium, at the time of settlement.

901. Interest. Lenders usually require that borrowers pay at settlement the interest that accrues on the mortgage from the date of settlement to the beginning of the period covered by the first monthly payment. For example, suppose your settlement takes place on April 1 6, and your first regular monthly payment will be due June 1, to cover interest charges for the month of May. On the settlement date, the lender will collect interest for the period from April 16 to May 1. If you borrowed $60,000 at 12 percent interest the interest item would be $303.30. This amount and per diem charges will be entered on line 901.

902. Mortgage Insurance Premium. Mortgage insurance protects the lender from loss due to payment default by the borrower. The lender may require you to pay your first premium or a lump sum premium covering the life of the loan in advance, on the day of settlement. The premium may cover a specific number of months. a year in advance or the total amount. With this insurance protection, the lender is willing to make a larger loan, thus reducing your downpayment requirements. This type of insurance should not be confused with mortgage life, credit life, or disability insurance designed to pay off a mortgage in the event of physical disability or death of the borrower.

903. Hazard Insurance Premium. This premium prepayment is for insurance protection for you and the lender against loss due to fire, windstorm, and natural hazards. This coverage may be included in a Homeowners Policy which insures against additional risks which may include personal liability and theft. Lenders often require payment of the first year's premium at settlement.

A hazard insurance or homeowner's policy may not protect you against loss caused by flooding. If your mortgage is Federally insured and your property is within a special flood hazard area identified by FEMA, you may be required by Federal law to carry flood insurance on your home. Such insurance may be purchased in participating communities under the National Flood Insurance Act.

1000. Reserves Deposited With Lenders. Reserves (sometimes called "escrow" or "impound"accounts) are funds held in an account by the lender to assure future payment for such recurring items as real estate taxes and hazard insurance. You will probably have to pay an initial amount for each of these items to start the reserve account at the time of settlement. A portion of your regular monthly payments will be added to the reserve account RESPA places limitations on the amount of reserve funds which may be required by the lender. Read "Reserve Accounts" in this booklet for reserve calculation procedures. Do not hesitate to ask the lender to explain any variance between your own calculations and the figure presented to you.

1001. Hazard Insurance. The lender determines the amount of money that must be placed in the reserve in order to pay the next insurance premium when due.

1002. Mortgage Insurance. The lender may require that part of the total annual premium be placed in the reserve account at settlement. The portion to be placed in reserve may be negotiable.

1003-1004. City/County Property Taxes. The lender may require a regular monthly payment to the reserve account for property taxes.

1005. Annual Assessments. This reserve item covers assessments that may be imposed by subdivisions or municipalities for special improvements (such as sidewalks, sewers or paving) or fees (such as homeowners association fees).

1100. Title Charges. Title charges may cover a variety of services performed by title companies and others and include fees directly related to the transfer of title (title examination, title search, document preparation) and fees for title insurance, legal charges, which include fees for lender's, seller's or buyer's attorney or the attorney preparing title work and fees for settlement agents and notaries. The specific charges discussed in connection with lines 1101 through 1109 are those most frequently incurred at settlement. Due to the great diversity in practice from area to area, your particular settlement may not include all of these items or may include others not listed. Ask your settlement agent to explain how these fees relate to services performed on your behalf. An extended discussion is presented in "Securing Title Services" earlier in this booklet.

1101. Settlement or Closing Fee. This fee is paid to the settlement agent. Responsibility for payment of this fee should be negotiated between the seller and buyer, at the time the sales contract is signed.

1102-1104. Abstract or Title Search, Title Examination, Title Insurance Binder. These charges cover the costs of the search and examination of records of previous ownership, transfers, etc., to determine whether the seller can convey clear title to the property, and to disclose any matters on record that could adversely affect the buyer or the lender. Examples of title problems are unpaid mortgages, judgment or tax liens, conveyances of mineral rights, leases, and power line easements or road right-of-ways that could limit use and enjoyment of the real estate. In some areas, a title insurance binder is called a commitment to insure.

1105. Document Preparation. There may be a separate document fee that covers preparation of final legal papers, such as a mortgage, deed of trust note, or deed. You should check with the settlement agent to see that these services, if charged for, are not also covered under some other service fees.

1106. Notary Fee. This fee is charged for the cost of having a licensed person affix his or her name and seal to various documents authenticating the execution of these documents by the parties.

1107. Attorney's Fees. You may be required to pay for legal services provided to the lender in connection with the settlement such as examination of the title binder or sales contract. Occasionally this fee can be shared with the seller, a so stipulated in the sales contract If a lawyer's involvement is required by the lender, the fee will appear on this part of the form. The buyer and seller may each retain an attorney to check the various documents and to represent them at all stages of the transaction including settlement. Where this service is not required and is paid for outside of closing, the person conducting settlement is not obligated to record the fee on the settlement form.

1108. Title Insurance. The total cost of owner's and lender's title insurance is shown here. The borrower may pay all, a part or none of this cost depending on the terms of the sales contract or local custom.

1109. Lender's Title Insurance. A one-time premium may be Charged at settlement for a lender's title policy which protects the lender against loss due to problems or defects in connection with the title. The insurance is usually written for the amount of the mortgage loan and covers losses due to defects or problems not identified by title search and examination. The borrower may pay all, a part or none of this cost depending on the terms of the sales contract or local custom.

1110. Owner's Title Insurance. This charge is for owner's title insurance protection and protects you against losses due to title defects. In some areas it is customary for the seller to provide the buyer with an owner's policy and for the seller to pay for this policy. In other areas, if the buyer desires an owner's policy he or she must pay for it.

1200. Government Recording and Transfer Charges. These fees may be paid either by borrower or seller, depending upon your contract when you buy the home or accept the loan commitment The borrower usually pays the fees for legally recording the new deed and mortgage (line 1201). These fees, collected when property changes hands or when a mortgage loan is made, may be quite large and are set by State and/or local governments. City, county and/or State tax stamps may have to be purchased as well (lines 1202 and 1203).

1300. Additional Settlement Charges. The lender or the title insurance company may require that a surveyor conduct a property survey to determine the exact location of the home and the lot line, as well as easements and rights of way. This is a protection to the buyer as well. Usually the buyer pays the surveyor's fees, but sometimes this may be handled by the seller (line 1301).

1302. Pest and Other Inspections. This fee is to cover inspections for termite or other pest infestation of the home. This may be important if the sales contract included a promise by the seller to transfer the property free from pests or pest-caused damage. Be sure that the inspection shows that the property complies with the sales contract before you complete the settlement. If it does not you may wish to require a bond or other financial assurance that the work will be completed. This fee can be paid either by the borrower or seller depending upon the terms of the sales contract. Lenders vary in their requirements as to such an inspection. Fees for other inspections, such as for structural soundness, are entered on line 1303.

1400. Total Settlement Charges. All the fees in the borrower's column entitled "Paid from Borrower's Funds at Settlement" are totaled here and transferred to line 103 of Section J, "Settlement charges to borrower" in the Summary of Borrower's Transaction on page 1 of the HUD-1 Settlement Statement. All the settlement fees paid by the seller are transferred to line 502 of Section K, Summary of Seller's Transaction on page 1 of the HUD-1 Settlement Statement.

Comparing Lender Costs

If a lender is willing to reduce its fees for such items as loan origination, discount points and other one-time settlement charges, it may gain it back if it charges a higher mortgage interest rate.

Here is one rule of thumb which you can use to calculate the combined effect of the interest rate on a fixed-rate loan and the one-time settlement charges (paid by you) such as "points." While not perfectly accurate, it is usually close enough for meaningful comparisons between lenders. The rule is, that one-time settlement charges equaling one percent of the loan amount increase the interest charge by one-eighth (1/8) of one percent. The 1/8 factor corresponds to a pay back period of approximately 15 years. If you intend instead to hold the property for only five years and pay off the loan at that time, the factor increases to 1/4.Here is an example of the rule. Consider only those charges that differ between lenders. Suppose you wish to borrow $60,000. Lender A will make a fixed-rate loan at 12.5 percent interest, but charges a two percent origination fee, a $150.00 application fee, and requires that you use a lawyer, for title work, selected by the lender at a fee of $300. Lender B will make a fixed-rate loan at 13 percent interest, but has no additional requirements or charges. As part of that 13 percent interest, though, Lender B will not charge an application fee and will absorb the lawyer's fee. What are the actual charges for each case?

Begin by relating all of Lender A's one-time charges to percentages of the $60,000 loan amount:

• 2 percent origination fee = 2 percent of loan amount
• $150 application fee = 0.25 percent of loan amount
• $300 lawyer's fee = 0.5 percent of loan amount
• Total = 2.75 percent of loan amount

Since each 1 percent of the loan amount in charges is the equivalent of 1/8 percent increase in interest, the effective interest rate from Lender A is the quoted or "contract" interest rate, 12.5 percent plus .34 percent (2.75 times 1/8), or a total of 12.84 percent interest.

Since Lender B has offered a 13 percent interest rate, Lender A has made a more attractive offer. Of course, it is more attractive only if you have sufficient cash to pay Lender A's one-time charges and still cover your downpayment moving expenses, and other settlement costs. This is simply a method to compare diverse costs on an equal basis. In the above illustration, Lender A does not receive the $300 lawyer's fee.

The calculation is sensitive to your assumption about the period of time you plan to own the home before paying off the mortgage. As indicated above, the factor increases to 1 /4 if you expect to pay off the mortgage in five years. Applying this new factor to the above illustration, the effective interest rate for Lender A would be 12.5 percent plus .69 (2.75 x 1/4) for a total of 13.19 percent interest. Lender A's offer is no longer more attractive than Lender B's which was 13.0 percent.

In doing these calculations you should also be careful as to which one-time fees you place into the calculation. For example, if Lender B in the above illustration did not include in this charge a legal fee but told you that you had to secure legal services in order to obtain the loan from him, you would have to add to Lender B's interest rate the legal fee that you had to incur.

You can use this method to compare the effective interest rates of any number of lenders if you are shopping for a fixed-rate loan. If the lenders have provided Truth-in-Lending disclosures, these are an even better comparative tool. You should question lenders carefully to make sure you have learned of all the charges they intend to make. The good faith estimate you receive when you make a loan application is a good checklist for this information, but it is not precise. Thus, you should ask the lender how the charges and fees are computed.

100. Gross Amount Due From Borrower. Page 1 of the HUD-1 Settlement Statement summarizes all actual costs and adjustments for the borrower and seller, including total settlement fees and charges found on line 1400 of Section L.

101. Contract Sales Price. This is the price of the home agreed to in the sales contract between the buyer and seller.

102. Personal Property. If, at the time the sales contract was made, you and the seller agreed that some items were to be transferred with the home, the price of those items is entered here. If it was agreed to include these items in the price of the home, their cost will be part of the sales price recorded on line 101. Personal property could include items such as carpets, drapes, stove, refrigerator, etc.

103. Settlement Charges to Borrower. The total charges for the borrower detailed in Section L and totaled on line 1400, are recorded here. This figure includes all of the items payable in connection with the loan, items required by the lender to be paid in advance, reserves deposited with the lender, title charges, government recording and transfer charges, and any additional related charges.

104-105. Additional Costs. This space is for listing any additional amounts owed the seller, such as reserve funds if the buyer is assuming the seller's loan. This may not be applicable to your settlement.

106-112. Adjustments. These include taxes, front footage charges, insurance, rent, fuel and other items that the seller has previously paid for covering a period which runs beyond the settlement date. The costs are usually divided on a proportional basis with the seller being reimbursed for charges accruing after the date of transfer of title.

120. Gross Amount Due. This is the total of lines 101 through 112.

200. Amounts Paid By or On Behalf Of Borrower. (See items 201-220)

201. Deposit or Earnest Money. This is the amount which you paid against the sales price when the sales contract was signed. It is credited to the purchase.

202. Principal Amount of New Loan. This is the amount of the new mortgage which you will pay to the lender in the future.

203. Existing Loan(s). If you are taking over the seller's mortgage(s) instead of obtaining a new loan, the amount still owed on those prior loans will b, shown here.

210-219. Adjustments. This includes taxes or assessments which become due after settlement, but which the seller pays because they cover a period of time prior to settlement. See"Reserve Accounts" for a further discussion of these matters.

220. Total Amounts Paid By/For Borrower. This is the sum of lines 201 through 219.

300. Cash At Settlement From/To Borrower. Remaining are the summary lines which are 301-303 for the borrower (and 601-603 for the seller). Subtracting line 302 (gross amount paid by or for the borrower) from line 301 (gross amount due from the borrower) results in the net cash the borrower must pay at settlement.

Reserve Accounts

In most instances, a monthly mortgage payment is made up of a payment on the principal amount of the mortgage debt which reduces the balance due on the loan, an interest payment which is the charge for use of the borrowed funds, and a reserve payment (also known as an escrow or impound payment) which represents approximately one-twelfth of the estimated annual insurance premiums, property taxes, assessments, and other recurring charges.

When settlement occurs you may need to make an initial deposit into the reserve account; otherwise, your regular monthly deposits to it will not accumulate enough to pay the taxes, insurance or Other charges when they fall due. Under RESPA, the maximum amount that the lender can require borrowers or prospective borrowers to deposit into a reserve account at settlement Is a total gross amount not to exceed the sum of: (a) an amount that would have been sufficient to pay taxes, insurance premiums, o' Other charges which would have been paid under normal lending practices, and ending on the due date of the first full monthly mortgage installment payment; plus (b) an additional amount not in excess of one-sixth (2 months) of the estimated total amount of taxes, insurance premiums and other charges to be paid on the dates indicated above during any twelve-month period to follow.

An illustration will help clarify this calculation. Assume the following set of facts on a loan, and that taxes are paid at the end of the period against which taxes are assessed.

• Settlement date April 30, 1997
• Due Date of first mortgage loan repayment June 1, 1997
• Taxes due yearly $720.00
• Monthly tax accrual $60.00
• Due date for taxes December 1st for the calendar year

The reserve amount for category (a) is $360.00. This represents the amount of taxes accruing between December 1, 1996 (the last tax due date) and May 30, 1997 ($60.00 x 6 months). Reserve amounts chargeable under category (b) could be up to two months advance payment times $60.00 or a total of $120.00. Therefore, total reserve deposits for taxes at settlement would be a maximum of $480.00. Changing the due date for taxes and/or the first mortgage payment results in a different reserve amount for the same illustration.

The same procedure is used to determine the maximum amounts that can be collected by the lender for insurance premiums or other charges. You need to know the charges and due dates in order to compute the amounts.

Once you begin your monthly mortgage payments, you cannot be required to pay more than one-twelfth of the annual taxes and other charges each month, unless a larger payment is necessary to make up for a deficit in your account or to maintain the cushion of the one-sixth of annual charges mentioned in (b) above. A deficit may be caused, for example, if your taxes or insurance premiums are raised.

You should note that the above monthly mortgage Payments reserve limitations apply to all RESPA covered mortgage loans whether they were originated before or after the implementation of RESPA.

Adjustments Between Borrower and Seller

The previous section dealt with setting up and maintaining your reserve account with the lender. At settlement it is also usually necessary to make an adjustment between borrower and seller for property taxes and other charges. This is an entirely separate matter from the initial deposit which the borrower makes into the new reserve account.

The adjustments between borrower and seller are shown in Sections J and K of the HUD-1 Settlement Statement. In the example given in the foregoing section, the taxes, which are payable annually, had not yet been paid when the settlement occurs on April 30. The borrower will have to pay a whole year's taxes on the following December 1. However, the seller lived in the house for the first four months of the year. Thus, one-third of the year's taxes are to be paid by the seller. Accordingly, lines 211 and 511 on the HUD-1 Settlement Statement would read as follows:

County taxes 1/1/97 to 4/30/97 $240.00

The borrower would be given credit for this amount in the settlement and the seller would have to pay this amount or count it as a deduction from sums payable to the seller.

In some areas taxes are paid at the beginning of the taxable year. If, in our example, the taxes were paid by the seller on January 1, 1997 for the following tax year ending December 31, 1997, the borrower will have to compensate the seller for the taxes paid by the seller for those months that the borrower will be in possession of the property (April 30-December 31). This adjustment will be shown on lines 107 and 407 of the HUD-1 Settlement Statement. With settlement occurring on April 30, those lines will read as follows:

County taxes 4/30/97 to 12/31/97 $480.00

This amount would be credited to the seller in the settlement. Similar adjustments are made for insurance (if the policy is being kept in effect), special assessments, fuel and other utilities, although the billing periods for these may not always be on an annual basis. Be sure you work out these prorations with the seller prior to settlement It is wise for you to notify utility companies of the change in ownership and ask for a special reading on the day of settlement, with the bill for presettlement charges to be mailed to the seller at his or her new address. This will eliminate much confusion that can result if you are billed for utilities which cover the time when the seller owned the property.