"Do you agree with the advice contained in the recent USA Today article, in which you were quoted, on how to save on settlement costs?"

That article made me realize that my views on how borrowers can best prevent overpaying on settlement costs are very different from those of most counselors. The author listened to my views but understandably went with the majority. This article will compare the different approaches.

The consensus view is that borrowers should prepare themselves to challenge individual settlement charges for which there is no justification, and those that are legitimate but overpriced. In preparation, they should educate themselves about the mortgage process in general, because loan providers will treat educated borrowers with more respect. They should also educate themselves about the various settlement charges so they can ask relevant questions and challenge questionable figures.

To educate themselves, borrowers should talk to other borrowers who have recently gone through the process, access relevant articles in the media, and visit informative Web sites, especially those of the U.S. Housing and Urban Development Department, the Federal Reserve and the Federal Trade Commission. They should also shop alternative sources and let loan providers know that they are shopping.

While these are all good suggestions, I believe that the main focus of this approach, to bargain down individual fees, is a mistake. It takes the borrower’s eye off the ball, which should be the interest rate and the total of all fees. Further, it ignores the fact that by the time the borrower is confronted with a list of specific fees, he may have little or no bargaining power. In addition, this approach fails to recognize important differences in dealing with lenders and with brokers.

In dealing with lenders, borrowers should distinguish points, which are an upfront charge by the lender expressed as a percent of the loan, fixed-dollar fees by the lender, and third-party charges. (Note: An "origination fee" is "points" under another name.)

When lenders quote interest rates, it is always accompanied by points. These are viewed as the "price" of the loan, which is reset every day as the market changes. Rate and points are reported in the media. In shopping loan providers, borrowers typically focus on rate and points.

In contrast, fixed-dollar fees are not reset with the market, are not reported in the media, and in most cases are not known to borrowers until they receive a Good Faith Estimate (GFE). Since a GFE typically is not issued until after a borrower submits an application, the borrower is at least partially committed to the lender by the time he discovers what the lender’s fixed-dollar charges are. His bargaining power arises solely from his willingness to start anew with another lender.

If he doesn’t have time for that because of an impending closing date on a house purchase, he has no bargaining power at all. It is no wonder that fixed-dollar fees are the major source of settlement-cost abuse. …CONTINUED

The remedy is very simple. When borrowers shop lenders, in addition to rate and points, they should ask for the total of fixed-dollar fees. Ignore the detail — the total is all that matters. Then ask the lender to guarantee the total in writing.

Lenders can guarantee their fixed-dollar charges with no risk to themselves except the loss of their capacity to overcharge you, and they will if necessary. Many lenders guarantee these charges as a matter of course, including the seven Upfront Mortgage Lenders listed on my Web site.

Third-party charges can’t be negotiated with the lender, and very rarely do lenders guarantee them. Focus on the largest charge, which is title insurance, letting the lender know you will be buying it yourself. Borrowers today can usually beat the prices charged by title companies selected by lenders or Realtors by purchasing it themselves online. I have recommended www.entitledirect.com. Other third-party charges are rarely a source of abusive overcharges.

Borrowers who deal with a mortgage broker rather than a lender can shift their focus from shopping settlement costs to negotiating with the broker. Borrowers should approach the broker as a service provider who gets paid a fee that is negotiated at the outset.

Just make sure that the broker fee includes any payment to the broker from the lender. Upfront Mortgage Brokers (UMBs) operate this way as a matter of course, and many other brokers are willing to do business this way if the borrower requests it.

One of the services UMBs provide to their clients is to protect them against lender overcharges on fixed-dollar fees. Dealing with a mortgage broker eliminates fixed-dollar lender fees as an issue to the borrower. The fees charged by the wholesale lenders that brokers deal with vary little from one lender to another. Upfront Mortgage Brokers explicitly guarantee lender fees once the lender has been identified. My comments about third-party charges above would apply to brokers as well.

Note: On Jan. 1, 2010, a new GFE will take effect along with some new protections for borrowers. Stay tuned.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.


What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

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