What Are Loan Fees In Residential Mortgage


When obtaining a loan, a borrower will incur a number of charges and costs. Many of these may be financed, such as paid out of loan proceeds which reduces the amount of cash in a refinance or applied to the purchase in a purchase loan. If paid for by the mortgage broker in exchange for a higher interest rate (YSP) they are financed. Others are paid up front or in cash at closing by the borrower.

A loan fee established as a percentage of the loan amount or principal balance may be referred to as “points.” One point is the same as one percent of the loan amount (not one percent of interest rate).

Fees that may be expressed as points include a loan origination fee, a mortgage broker’s fee, discount points and yield spread premiums, which are all percentages of the loan amount, or loan balance.

A loan origination fee covers the lender’s cost and profit for preparing documents and providing other services in processing the loan in-house.

The mortgage broker’s fee pays for a mortgage broker to originate the loan.

A prepayment penalty may be charged on a nongovernment-backed loan that is paid off early. It may be a percentage of the loan amount or be the amount of interest the lender would have earned for a specified period (e.g., interest for the following six months).

The par rate is the interest rate that would be charged without any yield spread premiums to increase it or discount points to decrease it.

Discount points are fees charged to a borrower for a loan at a reduced interest rate. As discussed earlier, one point of discount does not equal one point of interest.

Yield spread premiums (YSPs) are points credited for an interest rate above its par rate. “No closing cost” loans result from applying the YSP to pay the borrower’s closing costs so that they need not be paid up front. Some states prohibit the use of terms such as “No Cost” or similar claims in mortgage loan advertising as they are misleading and deceptive.

Rate sheets provide options that may be offered to borrowers in terms of interest rates and points charged. The more points paid by the borrower up front, the lower the interest rate charged over the duration of the loan. As the interest rate increases, fewer points will be paid. For a loan above the par rate, points may become a negative number on the rate sheet. Negative points mean the lender will credit the borrower with a YSP to reduce his closing costs.

For Example
Based on the rate sheet below for borrower-paid loan originator compensation, there are no points needed to obtain a loan at 6.25%. To buy his interest rate down, a borrower could pay 1 point and get a 0.25% interest rate reduction. To get extra cash at closing, equal to 1% of the loan amount, he could agree to pay 6.5%.

 

Interest Rate

Fee/Rebate

5.50%

3.00

5.75%

2.00

6.00%

1.00

6.25%

0

6.50%

-1.00

6.75%

-2.00

7.00%

-3.00

 

The formula for any loan fees that are expressed as points or percentages is:

Loan Amount x Percentage of Fees = Amount of Loan Fees

The phrases “3 points,” or “3 discount points,” and “3 percent loan fee” or “3 percent loan origination fee” all relate to a 3 percent fee. Loan Fees (or Points) = 0.03 x Loan Amount.

If the fee percentage needs to be calculated, this can be done by dividing the loan fees by the loan amount.

For Example
A borrower paid $300,000 for a home. He got an 80% loan, paying 1 point for a loan origination fee and 2 discount points.

  • The points amounted to 3% of the loan amount.
  • The loan was $240,000 (80% of the $300,000 price).
  • The points were $7,200 (3% of the $240,000 loan = 0.03 x 240,000).

 

What Are Prorations

Recurring expenses (e.g., property taxes, interest, insurance or homeowners’ association assessments) will generally be prorated at the time of closing. Prorating involves proportionately allocating an expense based upon the relative time for which a party is responsible for the expense. These costs must be included in the disclosures provided to the borrower prior to consummation of his loan. For example, if a sale closed three months into the tax year, proration would allocate the seller’s responsibility for the annual property tax to be one-quarter and the buyer’s responsibility to be three-quarters.

Proration is used to:

  • split the cost of monthly interest on an assumed loan, the cost of annual taxes or the cost of homeowners’ association fees between the buyer and seller.
  • determine how much the seller may be entitled to receive as a refund of a prepaid hazard insurance premium, if he cancels the policy before it expires.
  • determine how much of a full month’s interest a buyer or seller may owe a lender for use of its money for less than a full month.

Prorating may be performed using a 365-day year or a 360-day year:

  • In a 365-day-year prorate, the annual cost is divided by 365 to get the daily cost, and each month is considered to have the number of days it actually does have.
  • In a 360-day-year prorate, the annual cost is divided by 360 to get the daily cost, and each month is considered to have 30 days, regardless of the number of days it actually has.

In a leap year, 366 days would be substituted for 365.

Prepaid interest, or per diem interest, is the dollar amount cost of the interest that the buyer will be charged at closing for the use of the loan proceeds from the date the loan closes to the date the loan payment schedule begins, typically the first day of the following month.

In addition, the seller may have to pay interest on his existing loan at closing, since his last payment prior to closing covered the interest accrued in the month before the payment. Because interest is paid in arrears, a loan payment for April would include interest for the month of March. If the sale closed in April, the seller would owe interest for the use of the funds in April up to or through the closing date, either to the lender (if the loan were paid off) or to the buyer (if the buyer were to assume the loan).

The prorated interest amounts can be calculated using the following steps:

  1. Annual Interest = Loan Amount x Annual Percent Interest
  2. Daily Interest = Annual Interest ÷ Days in the Year (365 or 360)
  3. Prepaid Interest on New Loan = Daily Interest x Days from Closing to the Next Month (using the exact days in the month for a 365-day prorate, or 30 days for a 360-day prorate)
  4. Interest on Seller’s Existing Loan = Daily Interest x Days from Last Payment to Closing
For Example
For Example
A $100,000 loan with a 5.5% interest rate closes on August 17. This means the buyer will pay for interest that is charged starting on August 17. The loan payment schedule will “start” on September 1, with the first payment (covering the interest for September) due October 1.Using a 365-day year, the lender is owed interest for 15 days in August (31 days – 16 days after the release of funds on August 17).Annual Interest = $100,000 x 5.5% = $5,500
Daily Interest = $5,500 ÷ 365 = $15.07
Prepaid Interest = $15.07 x 15 = $226.05Using a 360-day year, the lender is owed interest for 14 days in August (30 days – 16 days prior to release of funds on August 17).

Annual Interest = $100,000 x 5.5% = $5,500
Daily Interest = $5,500 ÷ 360 = $15.28
Prepaid Interest = $15.28 x 14 = $213.92

 

In some cases, when the loan closes very early in the month, the lender will start the loan term earlier and rebate the interest to the borrower. For example, if the loan above were to close on August 4 instead of August 17, the loan payment schedule would start on August 1; the first payment would be due on September, 1 rather than October 1; and the lender would credit four days of interest back to the borrower.

Mortgage Lock-ins

Any quoted interest rate is binding only if the loan were to be settled within the time period specified in the Loan Estimate provided by the loan originator, which may be one day or several days. If a borrower chooses to float the interest rate, the rate will not be set until closing, unless the borrower obtains a lock-in (also called a rate lock or rate commitment). This is a lender’s promise to hold a certain interest rate and a certain number of points for the borrower for a specified period of time while his loan application is processed. In order for the lock-in agreement to be enforced by the borrower, it must be in writing and be acknowledged by the lender. If the loan is not settled within the lock-in period, the locked-in rate and points may be lost.

Most lenders will not charge a lock-in fee to lock an interest rate or a number of points for a limited period, such as 10 days or 60 days, but they may charge a fee for a longer lock-in period. The fee is usually expressed as points (e.g., 1/4 point for a 90-day lock), but it might be a flat fee or even a fraction of a percent added to the locked-in rate. It may be charged at settlement or up front.

If a rate lock expires, the prevailing rate at the time becomes the new rate of the loan and the loan rate floats until a new rate lock is created. Among the factors affecting the fee is the length of the lock-in period (e.g., the longer the period, the greater the risk to the lender that interest rates will have risen) and the lock-in option selected.

 

Some of the lock-in options that might be available to a borrower include:

  • locked-in interest rate and locked-in points. This is a “true lock-in,” as it freezes the rate and points.
  • locked-in interest rate and floating points. This freezes the rate but allows points to fluctuate with market conditions. Therefore, if market interest rates drop, the points may drop; if rates rise, the points may increase. However, the points may be locked in at some time before settlement at the then-current level.
  • floating interest rate and floating points. Often called a “float-to-lock,” this freezes the interest rate and the points at some time after the application but before settlement.
  • float-down rate lock. This caps the interest rate and the number of points but allows the borrower to get the loan at a lower rate if rates float down.

Upon loan approval, the lender will provide a loan commitment promising to grant a loan at specific terms, including the loan amount, the length of time the commitment is valid, and any conditions for making the loan, such as receipt of a satisfactory title insurance policy protecting the lender. These conditions are called closing stipulations and may be pre- or post-closing. A loan will not be funded by the lender until all post-closing stipulations are met.

Mortgage Lock-ins

A borrower’s monthly mortgage payment will repay money borrowed plus interest. It may also include a reserve payment (also known as an escrow or impound payment) that represents approximately 1/12 of the estimated annual hazard and flood insurance premiums and property taxes. Some escrow accounts will include assessments of special improvements, homeowners’ association fees and other recurring charges.

The escrow account is required for:

  • all FHA and VA loans.
  • conforming conventional loans for greater than 80 percent of the appraised property value.
  • higher-priced mortgage loans secured by a first lien on the borrower’s principal dwelling.

When there is need of an account, the borrower may be required to make an initial deposit into the reserve account at settlement to ensure that the regular monthly deposits will accumulate enough to pay the property taxes, insurance premiums or other charges when they are due.

Tax Escrow and Insurance Reserves

A borrower’s monthly mortgage payment will repay money borrowed plus interest. It may also include a reserve payment (also known as an escrow or impound payment) that represents approximately 1/12 of the estimated annual hazard and flood insurance premiums and property taxes. Some escrow accounts will include assessments for special improvements, homeowners’ association fees and other recurring charges.

The escrow account is required for:

  • all FHA and VA loans.
  • conforming conventional loans for greater than 80 percent of the appraised property value.
  • higher-priced mortgage loans secured by a first lien on the borrower’s principal dwelling.

When there is need of an account, the borrower may be required to make an initial deposit into the reserve account at settlement to ensure that the regular monthly deposits will accumulate enough to pay the property taxes, insurance premiums or other charges when they are due.

 

The maximum amount a lender can collect for this deposit cannot exceed the sum of:

  • an amount sufficient to pay taxes, insurance premiums or other charges up to the due date of the new loan’s first full monthly mortgage installment payment; plus
  • an additional amount sufficient to pay future estimated taxes, insurance premiums and other charges, not in excess of two months’ worth, which is 1/6 of the estimated charges for the following 12 months.
For Example
The settlement date is May 31, the due date of the borrower’s first mortgage loan payment is July 1, and annual taxes are $2,160.

  • The monthly tax accrual: $2,160 ÷ 12 months = $180

The due date for taxes is November 15 for the tax year. The reserve amount represents the amount of taxes accruing between November 15 of last year and June 30.

  • The reserve amount: $180 x 8 months = $1,440

Additional reserve amounts can be required of up to two months’ advance payment.

  • Two months’ estimated charges: $180 x 2 months = $360

The maximum total reserve deposit for taxes at settlement is: $1,440 + $360 = $1,800

If the due date for taxes were April 30, the reserve amount would be due for only May and June.

  • The reserve amount: $180 x 2 months = $360
  • Two months’ estimated charges: $180 x 2 months = $360
  • Maximum total reserve deposit: $360 + $360 = $720, equal to four months of taxes

 

The same procedure is used to determine the maximum amounts that can be collected by the lender for insurance premiums or other charges.

Once monthly mortgage payments begin, the borrower cannot be required to pay more than 1/12 of the annual taxes and other charges each month, unless a larger payment is necessary to make up for a deficit in his account (caused by increased taxes or insurance premiums) or to maintain the two-month cushion, which is 1/6 of annual charges.

A clause in the mortgage or trust deed will generally require the borrower to maintain property insurance (i.e., hazard insurance) and provide that, if the policy lapses because of nonpayment of the premium, the lender can declare the buyer in default and force place the insurance (i.e., pay for the coverage and require that the borrower reimburse the lender in order to avoid foreclosure). A mortgagee clause in the insurance policy will include the lender as an additional loss payee so that, in the event of a covered loss, the lender will have some say over how the insurance claim proceeds are used (e.g., to repair the damage or, if the borrower and lender agree, to apply them to the balance of the debt instead of repairing the damage).

 

Fannie Mae requires that for any first-lien mortgage (excluding a reverse mortgage), the minimum hazard insurance coverage required is the lesser of:

  • 100 percent of the insurable value of the improvements, as established by the property insurer; or
  • the unpaid principal balance of the mortgage, as long as it equals the minimum amount (80 percent of the insurable value of the improvements) required to compensate for damage or loss on a replacement cost basis. If it does not, then the coverage that does provide the minimum required amount must be obtained.
For Example
A buyer obtains a $160,000 loan to purchase a property with a sales price of $200,000. The insurer determines the insurable value of the improvements is $150,000. Therefore, the purchaser need obtain only $150,000 of hazard insurance.The insurable value does not include the value of the land.

 

With regard to one- to four-family investment property in which the owner will not live, Fannie Mae and Freddie Mac require six months of principal, interest, and property taxes and insurance (PITI) in reserve. This reduces the lender’s risk in the event the owner experiences a period of vacancies.

 

Flood Insurance Legislation

Dwelling and homeowners insurance cover losses to improvements (not to land) caused by fire, windstorms and other natural causes. However, these policies do not cover a property owner against catastrophic losses from such causes as earthquakes and floods. To get such coverage, he can purchase earthquake coverage and/or flood insurance as endorsements or separate policies.

The National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973 prohibited any lender from making, increasing, extending or renewing a loan that will be benefited by any federal program (e.g., an FHA loan) and that is secured by improved real estate or a mobile home located in an area designated by the Federal Emergency Management Agency (FEMA) as a Special Flood Hazard Area (SFHA), unless the building or mobile home and any personal property securing the loan are covered by flood insurance:

  • for the entire loan term.
  • with a limit of at least the lesser of:
    • the outstanding principal loan balance; or
    • the maximum limit of coverage made available under the Flood Disaster Protection Act for the particular type of property. Coverage is limited to the overall value of the property less the value of the land.

 

Flood Zone Determination

In his appraisal, an appraiser will review a FEMA Flood Insurance Rate Map and show the FEMA flood zone designation, map panel number, map number and map date in the report. However, the final responsibility for determining whether a property is located in an SFHA rests with the originating lender. Therefore, the mortgagee will often obtain a flood zone certification, independent of any assessment made by the appraiser.

Flood insurance is required for property improvements located in an SFHA Zone A (an area subject to inundation by a 1%-annual-chance flood event) or a Zone V (an area along the coast subject to inundation by a 1%-annual-chance flood event with additional hazards associated with storm-induced waves).

Fannie Mae, Freddie Mac and Ginnie Mae are required to have procedures reasonably designed to ensure that required flood insurance is in place throughout the term of any mortgage loan they purchase or guarantee. Therefore, they require lenders and servicers to monitor, on an ongoing basis, the flood zone status of any loans sold to or serviced for them. In order to comply with these requirements, mortgage lenders must obtain an initial flood zone determination before originating a mortgage loan and take steps to monitor the flood zone status of any improvements securing the loan throughout the loan term.

 

A borrower may be charged:

  • a fee for flood zone determinations and life-of-the-loan tracking, not to exceed the actual charge of any third party used to make the determination.
  • an initial insurance premium at closing and an ongoing annual premium for any required flood insurance. If an escrow account is required for taxes and hazard insurance premiums, escrow must also be used for required flood insurance premiums.

If, at any time during the life of a loan, the lender determines that the property is in an SFHA and is not covered by flood insurance, it will instruct the borrower to obtain flood insurance. If the borrower does not promptly purchase the required insurance, the lender will force place (i.e., purchase) the insurance on the borrower’s behalf.

Note
The Biggert-Waters Flood Insurance Reform Act of 2012 contains many reforms and changes, including clarifying that private flood insurance may satisfy flood insurance requirements if it meets certain standards. Fannie Mae, Freddie Mac and Ginnie Mae are required to accept flood insurance from private providers as an alternative to National Flood Insurance Program (NFIP) policies. The Act also amended RESPA to require an explanation of flood insurance and the availability under the NFIP or from a private insurance company.

 

Refinancing Considerations

Reasons a person might consider refinancing a home mortgage include:

  • lowering monthly payments.
  • withdrawing equity (cash-out mortgage refinance) to repay the previous mortgage and meet other financial expenses.
  • converting an adjustable-rate mortgage to a fixed-rate mortgage.
  • stopping the payment of private mortgage insurance.

Just as financing a new loan has a cost, so does refinancing. These costs may include, but are not limited to:

  • application, loan origination and appraisal fees.
  • escrow and title insurance costs.
  • per-diem interest.
  • tax and insurance reserves.
  • prepayment penalties on the existing loan.

Lenders have the responsibility to prove there is tangible net benefit to the borrower before proceeding with a refinance application. For example, a lender cannot charge $10,000 in fees just to get a one-quarter point reduction to the borrower’s interest rate. The benefit to the borrower would not justify the monetary cost.

A tangible net benefit to the borrower may be:

  • refinancing an adjustable-rate mortgage to a fixed-rate mortgage.
  • depending on the type of ARM being refinanced:
    • a reduction of at least five percent in the principal and interest payment; or
    • a new interest rate that is at least two percentage points below the current rate.

 

Prepayment Penalties

Loans may be made with or without a prepayment penalty provision. The presence of a prepayment penalty can affect the interest rate the lender will offer and create an additional cost when refinancing the loan.

A prepayment penalty is a charge imposed by the lender if the borrower repays the loan within a specified period of time, generally within five or fewer years from the date of consummation of the loan. A loan with a prepayment penalty will generally have a lower interest rate than one without, because it discourages the borrower from refinancing immediately if market interest rates drop.

All prepayment penalties will apply to repayment due to refinancing, because refinancing would occur when the borrower could obtain lower rates elsewhere and the lender would probably not be able to loan the money out again at the rate being charged the borrower. A penalty that applies only to refinancing is called a soft prepay penalty; one that applies to any prepayment, including from the sale of the property, is called a hard prepay penalty.

 

A penalty is most often expressed as a percentage of the outstanding loan balance at the time of prepayment or as a specified number of months of interest.

For Example

A $100,000 loan at 6% interest has a 2% penalty for prepayment within two years. If, at the time of prepayment, the loan balance were $98,750, the penalty would be 2% of $98,750.

A $100,000 loan at 6.5% interest has a penalty equal to six months’ interest if the loan were repaid within three years. If, at the time of prepayment, the loan balance were $98,750, the penalty would be 3.25% of $98,750.

A prepayment penalty may also be imposed for partial prepayments above a certain percentage of the loan balance within a certain period of time. Typically, a borrower may not prepay more than 20 percent of the loan balance in a single calendar year without penalty.

 

Refinancing Cost Recapture

A borrower intending to keep the refinanced loan for a number of years typically saves money by paying his loan costs up front, because his interest rate or loan amount will be lower and he will pay the lower rate year after year. Of course, if he does not keep the loan for the anticipated period, his costs may be more than if he had financed them in the new loan. For example, if he saves $40 a month in mortgage payments, his savings is $480 per year. If he paid loan and closing costs totaling $2,000, it would take more than four years to recapture his refinancing costs ($2,000 ÷ 480 = 4.16 years, or 4 years and 2 months).

Refinancing makes sense when a no-cost mortgage (no out-of-pocket costs) includes points and closing costs:

  • in the new interest rate, which is lower than his current rate; or
  • in the new loan amount, when the new monthly payment is still lower with the same or shorter loan term.

However, the borrower’s interest rate or mortgage payments will be higher than if he had paid his costs up front.

 

 

 

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