Getting a mortgage is one of the largest financial decisions we will make in our lives. With that large decision comes a number of equally important questions, like, which type of loan will I get, what rate is best for me, which lender will I go with, and is it better to pay more now or pay more later?
Many of the answers to these questions will be on the borrower’s mortgage loan estimate (LE), also known as a good faith estimate (up until 2015). The LE, as explained below, is an important mortgage or refinance document for borrowers to know all their costs and expenses involved with securing a loan. Knowing which set of items appear on a loan estimate for your refinance or mortgage will help you choose the best lender for your home!
The primary set of items that appear on a loan estimate are:
- Principal loan amount
- Interest rate & APR
- Upfront costs (closing cost)
- Mortgage points & credits
- Prepaids, escrow, & taxes
Even if you refinance often, understanding the costs and the fees that go into the loan can help you figure out the answers to these questions and determine what’s best for your budget.
Mortgage loan estimate explained
A loan estimate is a standard mortgage document (see also this PDF) that your lender will provide you that details all the expenses and costs of your home loan. On top of the principal amount that you’re borrowing and your mortgage interest rate, there are other closing costs. Every real estate transaction comes with them, and they include fees, insurance, taxes, and administrative costs, even if you pay in cash. And if you’re buying a home, you can also include your down payment and your earnest money. Today, we’ll dig into where each cost comes from and how to approach it.
Any lender you speak with is legally required to send you a loan estimate (LE), within three business days of submitting a formal application.
Keep in mind that even though receiving an LE is not an official loan approval, it does simplify the process for you by explaining the terms of the loan so you can actively compare different loan offers. A mortgage or refinance loan estimate is super helpful in informing you, as a home buyer or owner, on how you want to proceed (since it provides all the financials).
The following post will walk you through a mortgage LE by breaking down all the associated costs that you might have with your future loan. If you read the whole post, you should have a better understanding of closing costs and become a lot more confident in making decisions to lock in your rate and get started with your mortgage journey.
What items appear on a loan estimate
What appears on a mortgage loan estimate is the same for everyone. The items that appear on your mortgage loan estimate docs include your loan amount, services you cannot shop for (appraisal fees, credit report, flood certification, etc), and services you can stop for (title insurance, fees, etc). It also includes other costs like taxes, prepaids, escrow payments, etc.
If you have your own LE, pull it up so you can follow along. The LE is an industry-standard document so every lender is going to have it in the same exact order and foundation, with a breakdown of all the terms, and expected costs with your loan.
Page 1 of your mortgage loan estimate
Page one of the loan estimate has all of your loan information on it, including key parts to help you compare the different loan types and rates. You’ll also see your estimated monthly payments, including any escrow payments, private mortgage insurance (PMI), and potential closing costs. Now let’s get into the main figures you’ll see…
Principal loan amount
Your principal loan amount is pretty self-explanatory: it’s the total amount of money you’re borrowing. This doesn’t include any taxes, insurance, or interest.
Interest rate & APR
Next are the interest rate and the APR. These are two commonly confused costs, but we do express them differently. So the interest rate is the cost of borrowing a loan from a lender. It’s expressed as a percentage of the principal loan amount.
On the other hand, the annual percentage rate or the APR gives you a fuller picture than the interest rate alone. It includes interest, fees, and other charges or points. Additionally, you may also have private mortgage insurance (PMI). PMI is required by all lenders for conventional or FHA loans unless you put down 20% or more. Or for those of you who are refinancing your mortgage, you have to have at least 20% of the equity in your home.
Page 2: all the upfront costs of your loan
On page two of your loan estimate, you’ll see the upfront cost of your loan, including what’s included in your closing costs. This page might feel a bit overwhelming because it does have a full breakdown of everything but will help to separate things further. Let’s start with the loan costs.
Page two of your loan estimate divides all your closing fees into two main categories: loan costs and other costs.
- Loan costs: section A, B, C, D (sections A to C equal section D)
- Other costs: section E, F, G, H (sections E to H equal section J, if you have any lender credits, as I mentioned before, you’ll see those here as well)
Section A of Closing Cost Details
Section A is all about origination charges, including any mortgage points you elect in exchange for a lower interest rate. There’s also a possibility of processing, origination fees, and underwriting costs, which are quite common. Although in the past, the origination fee has helped clients compare loan estimates between different lenders (to find the best lender), many of the online lenders are dropping these fees completely so you may not see any. If that’s the case, you’ll only see things that you choose to include in your loan, such as points or credits.
Points vs Credits
Speaking of points and credits, these are costs associated with the trade-off between paying more upfront versus across the life of the loan. As a borrower you need to figure out what your financial goals are — is your goal to have the lowest monthly payment possible or have the lowest amount of closing costs? This matters because it will help you decide if you want points or credits.
- Mortgage Points are one-off fees that you would pay at closing that can bring down your interest rate, which in turn will lower your monthly payment. How soon you plan to refinance your home (or move out) is probably the largest factor in determining whether you should buy points or not (hint: if you plan to refi soon or move out, do NOT buy points).
- Mortgage Credits are on the other side of the spectrum. It’s money that the lender is giving you towards your closing costs. However, they do typically end up increasing your monthly payment over the life of the loan.
Credits are found in Section J under lender credits while points are typically located in Section A.
Section B: Services You Cannot Shop For
Moving on, Section B includes services you cannot shop for — they must be paid for by the borrower and set by the lender. The largest expense you’ll see here is your appraisal, which confirms the value of the property. There is a one-time fee for the home appraisal and it must be completed by a licensed appraiser (independent third party).
You will also see your credit report fee and flood certification fee. The credit report fee is a fee that goes directly to the credit bureaus, and that’s the cost for filling your hard credit report and the flood notification fee is used to verify that your property does not reside in the flood zone.
You may also have other fees as some lenders may also charge subordination fees or condo HOA fees, which can be found in this section.
Section C: Services You Can Shop For
Section C outlines services you can shop for. This section in your mortgage or refinance loan estimate details the cost of mandatory third-party services, like title checks, property checks, and home inspections.
These are fees that don’t involve the lender but need to be paid at closing. These third-party fees are distinguished by whether you can choose them or if they’re set in stone. Let’s go down the line of what might be included:
- Title services — this verifies that the seller owns this home and has legal authority to transfer the title (deed) to you free and clear. Costs associated with this include:
- Lender’s title insurance (protects the lender from financial loss due to defects in the title, as well as the cost of getting the title work)
- Owner’s title insurance (protects the buyer from financial loss due to defects in the title)
- Settlement fees
- Messenger and recording fees
- Deed preparation fees
- Homeowner’s Insurance — There are a plethora of different homeowners insurance companies that the buyer can choose from. This is completely out of the control of the lender so you, as the buyer, should do your due diligence and choose an insurance company with a strong reputation. This number will determine, and show up in, your closing costs.
Section E, F, H, G: Prepaids, escrow, & taxes
And finally, sections E, F, and G, are escrow, prepaids, and tax payments. These LE sections represent third-party fees and costs, from homeowners insurance to property taxes to PMI costs (if you have less than 20% down). These costs are static (they cannot change) regardless of which lender you choose. They’re determined by other parties (not your lender), such as the county’s clerk’s office, or your homeowner insurance company.
Prepaids and escrow amounts are upfront payments that are related to the home itself rather than the lender or third parties. In my professional experience, they can be a challenging loan cost for clients to wrap their heads around.
Prepaids typically include homeowner’s insurance and property taxes, which are updated every year and determined by your county clerk’s office. These are collected as prepaid amounts because your lender wants to make sure your homeowner’s insurance premium and property taxes are going to be paid.
If you waived your escrow account and are on a monthly pay plan for your homeowner’s insurance, expect your lender to collect at least three months of homeowners insurance payments on your closing disclosure to ensure your policy is paid through your first mortgage payment.
It’s important to know that prepaid and escrow may change throughout the processing of your loan as your lender gathers tax and homeowner’s insurance information from you and the county. If you have any specific questions about these numbers or why these numbers may have changed, be sure to reach out to your mortgage home advisor.
Refinancing prepaids & escrow
If you’re refinancing, your lender can sometimes use existing escrow funds for prepaid charges — speak to your lender to confirm.
Calculating Cash to Close
For homebuyers, you’re closing costs plus your down payment, and any seller credits will be your cash to close. Generally, closing costs range between two to five percent of the loan amount and usually include lender’s fees, third-party fees, and prepaid charges. The “cash to close” is the total amount that you’ll need to bring to the table at closing.
A down payment is typically something that is involved in a purchase of a home, not a refinance. This payment is the amount of money that you’re paying upfront outside of closing costs. It determines the initial equity that you have in your home and will also determine if your loan requires mortgage insurance (PMI or MIP). It’s typically expressed as a percentage of the home’s purchase price, and this amount will be included in your final cash-to-close number.
Page 3: Principal, interest, insurance, and more!
Next up is page 3. This page of the loan estimate illustrates what you will have paid in principal, interest, mortgage insurance, and loan costs over five years, including how much of the principal you will have paid off. You’ll also see your annual percentage rate (APR), and your total interest percentage (TIP).
The TIP is the total amount of interest that you will pay over the life of your mortgage, and it’s written as a percentage of your loan amount.
Finally, you’ll see other considerations specific to your lender and some third-party services, like late payment penalties, the ability to refinance, and how your loan will be serviced.
Page 4 & 5: Additional info about Section C (Services you can shop for)
On pages four and five of the loan estimate, you have additional information about the services that you can shop for (Section C). You’ll also notice any change of circumstance, whenever your loan or pricing changes in any way, you will receive a new loan estimate. This page will provide you with a very high-level understanding of what changed on your newborn estimate.
Now you know which set of items appears on a loan estimate for mortgage or refinance
If you’ve made it this far, congratulations! You now know how to read a home loan estimate as we’ve walked you through each step of the mortgage LE. If you have any additional questions, please email me or submit a comment below!