What is a Loan Estimate?
The new Loan Estimate (LE) was introduced in October 2015 as a federal standard form that includes the interest rate, monthly payments, and total closing costs for a mortgage loan application. The lender is required to send you a Loan Estimate within 3 business days after applying for a mortgage. Even though this form attempts to help the consumer understand the loan payment breakdown and the costs, it can still be very confusing. The language on the form is murky and some of its terminology needs to be explained.
In particular, I would like to point out that the “Loan Origination” fees you see on the Loan Estimate refers to “origination charges” for things like processing the loan. But these fees are not an “origination fee” in the historical sense where an origination fee used to be 1% of the balance of the loan. Also, the term discount points can make it seem like you are getting a discount on your mortgage, but it is more similar to a fee. Discount points are paid to buy down the interest rate and are a percentage of the loan amount. The semantic difference between origination fees and discount points seems slight, but the actual differences are great.
Discount points and origination charges are very important terms to understand when reviewing the Loan Estimate for a mortgage.
What are discount points on a mortgage Loan Estimate?
Discount points are prepaid interest that lenders buy then offer as mortgage fees to lower the interest on future mortgage payments.
“Each point costs 1% of the total loan amount and depending on the borrower, each point lowers your interest rate by one-eighth to one one-quarter of your interest rate.” – Investopedia
The discount points are tax-deductible, which may sound appealing. Truth be told, the lender is benefiting from offering you these discount points by charging you a fee for them. Therefore the discount is not free. The lender buys the points then sells them to you; in turn getting the money upfront instead of with a higher interest rate. When you purchase the points it will decrease the interest rate on your loan immediately. To recoup the savings of the discount points it will take a number of years and you should do the math to see if paying points makes sense for how long you plan to live in the property.
If you plan to live in your home for a long term you may benefit from applying discount points to your mortgage. Ask your lender to see the difference between a mortgage with and without the discount points. If you only plan to stay in your home for a shorter number of years, like 3-5 years, you may be paying more upfront than what is needed. See a more in-depth comparison here: https://www.getloans.com/paying-points-on-a-loan/
What is a “Loan Origination” fee on a Loan Estimate?
This is not an “origination fee” in the traditional sense, where the bank or broker would be charging you a percentage of the loan amount and call it an “origination fee”. What the form is referring to as “Loan Origination” fees are a sum total of the application and processing fees. The federal rule makers consider the charges that the bank and broker charge the consumer to “originate” the loan as origination charges, so lenders must call them “origination fees”. Therefore the ‘origination fees’ are not like the old “1% origination fee” that used to be charged. In this case, it is simply a summary of various charges:
- $565 Application fee
- $395 Processing fee
- $34 credit report
- $8 flood certification fee
- $1,002 total “origination fees”
So, there is no 1% origination fee or origination points in the origination fees. The Feds just errantly chose confusing language that sounds like the old “1% origination fee” to describe the fees that lenders charge to originate a loan. They should have used “processing charges” in my opinion, instead of “Loan Origination” fees, as it would have been less confusing.
Consider the Loan Estimate as a guideline since the estimate has some variables. In particular, the “Services You Can Shop For” section is only an estimate. These service estimates can vary based on the company quotes that you will obtain on your own. Get a jumpstart on them and ask for quotes from local service providers for the following:
- Pest Inspection Fee
- Survey Fee
- Title – Insurance Binder
- Title – Lender’s Title Policy
- Title – Settlement Agent Fee
- Title – Title Search
Overall, the Loan Estimate should help you review the details of your mortgage loan, and see exactly where your money is going. It breaks down the mortgage loan costs and rates in a simple-to-read layout, which allows you to quickly understand what to expect on your loan. It answers “Yes” or “No” questions on whether the loan has a balloon payment or an adjustable interest rate. Some of these terms may have caused less-experienced homeowners hardship in the past during the housing bubble crisis. Since then, qualitative and quantitative reports have studied how the disclosure estimates can be improved upon. Today the Loan Estimate is an important step to disclosure transparency in the mortgage industry.