Nearly half of homeowners make a huge mistake during the homebuying process, according to the Consumer Financial Protection Bureau (CFPB) — they don’t compare lenders when shopping for a mortgage.
Not only do many consumers neglect to compare lenders in the process of purchasing a home, but a number of homebuyers express being unfamiliar with important factors that can greatly affect the cost of their mortgage as well, including:
- The different types of mortgages
- The money required at closing
- The process of getting a mortgage
- The income needed to qualify for a mortgage
- The down payment requirements
- Current mortgage rates
- Personal credit history or credit score
This unfamiliarity increases even more for first-time home buyers. Without knowing what to expect, homeowners can go into the mortgage process unaware of what they are actually getting and paying for. From title searches to pest inspections, appraisals and more, the average homebuyer is purchasing much more than a home.
How much money do you bring to the closing table? Will you pay your taxes and insurance outright or have them escrowed (rolled into your mortgage payment)? What loan fees are set in stone versus ones you can shop around for? Will your loan interest rate remain the same or change at some point?
Depending on your choice for a home loan product, the outcome can have a big effect on your finances. A home is such a significant purchase — in fact, it’s probably the biggest purchase you’ll ever make — that just a few percentage points difference in interest can add up to tens of thousands of dollars saved (or lost) over the life of the loan.
Fortunately, it’s not all that difficult to compare mortgage loan offers between lenders these days. There’s been some standardization in the way banks present mortgage estimates to loan applicants. This is where the Good Faith Estimate (GFE) comes into play.
What is a Good Faith Estimate?
A Good Faith Estimate (GFE) is a standard template used by lenders to give you the rundown on your loan terms: interest rate, origination fees, monthly payments and more. However, you should know that as of October 2015, the Good Faith Estimate document was replaced by a document called the Loan Estimate for most types of loans.
The whole idea behind the GFE aka the Loan Estimate is to help consumers understand all the costs associated with their home loan, from the length of the loan to settlement fees you’ll have to pay at closing. It was also designed to inform consumers of which charges could change and when they could change for closing purposes.
With all of this information provided in a standardized format, the aim was to encourage borrowers to shop around for the best loan and loan terms for their home loan.
Before standardized estimate templates came on the scene, the average Joe consumer had a heck of a time deciphering all the loan “mumbo-jumbo” because there were many ways to state (and maybe even hide) fees associated with obtaining a home loan. Based on all the ways lending costs and fees could be itemized and stated, it became difficult to truly compare rates and get the very best rate for these home loan products.
Though the GFE was a great improvement over prior mortgage estimate methods, there were still more strides to be made in the usability and clarity. In other words, extensive testing showed that the average consumer still needed help with identifying key information pertinent to their loan terms. Enter the Loan Estimate.
GFE vs Loan Estimate: What are the differences?
GFEs were replaced with Loan Estimates after the CFPB initiated the Know Before You Owe mortgage disclosure rule. That effectively replaced Good Faith Estimates with the new Loan Estimate document. You’ll most likely see a loan estimate document when you apply for a traditional mortgage. Loan Estimates do not apply for reverse mortgages, HELOCs, and a handful of other real estate transactions.
According to the CFPB, the main objectives of the Loan Estimate form include helping consumers:
- Understand their loan options
- Shop for the mortgage that’s best for them
- Avoid costly surprises at the closing table
There are some differences in design and usability that make the Loan Estimates different from the GFE in a few ways.
Easier to understand
The Loan Estimate form is designed to help you better identify loan risk factors, such as potential interest rate changes and negative amortization features. In addition, you should be able to see the overall cost of your home loan over both the short and long term. Finally, you should be able to understand, very clearly, what your monthly loan payments will be.
Better comparison shopping
A great thing about the Loan Estimate is that it’s easier to compare offers from competing lenders with a table that is clearly labeled for the sole purpose of comparison. Also, there’s a section on the Loan Estimate clearly labeled “Services You Can Shop For” and “Services You Cannot Shop For” in case there are other areas you can save money in the loan process.
Avoiding costly surprises at the closing table
Jonathan Dyer is a loan originator at Neighborhood Lending Services. He explains how the Loan Estimate further enforces provisions that started with the GFE and its similar predecessors. The Loan Estimate provides additional protections against last minute changes in loan terms and fees.
“Often, some fees [as stated in the disclosure] would be subject to change and would increase at the final hour [before closing],” he told MagnifyMoney. “Regulatory agencies have now prohibited any increase of disclosed fees without a significant change in the loan purpose or loan amount.”
Because of this, there are strict rules around what loan terms can and cannot change at closing. Another plus is that there are provisions that give you the chance to compare your Loan Estimate against your final Closing Disclosure at least three days before you come to the closing table.
Another improvement with the Loan Estimate came with reducing the number pages consumers receive during the loan application process.The Loan Estimate effectively replaces both the GFE along with the Initial Truth In Lending (TIL) Disclosure and consolidates this into one, shorter form.
You can see example templates of each form before and after to get an idea of the differences (click images below to access to the PDFs). From the thumbnail view, we can see pretty easily that the form is shorter and potentially less confusing for loan applicants.
When do I get a loan estimate?
Now that you know about how the estimate process and documentation have improved for loan applicants, you should know about what starts the clock on when you should have your Loan Estimate in hand.
Loan Estimates must be provided to consumers within three business days of submitting a loan application providing six pieces of information to a lender:
- Social security number (for credit reporting)
- Property address
- Market value of the property (normally the sale price)
- Loan amount
According to federal regulations, this is not an optional step. Lenders must provide this document to loan applicants and it has to be within three business days, or they could be in violation of the law.
Key terms to understand
Once you receive your Loan Estimates, pay attention to key terms and make sure you are comfortable with the impact these obligations will have on your overall finances.
- Loan amount. The amount you are borrowing from the bank. Your loan should be reduced by the amount of your down payment.
- Rate lock. Explains if your interest rate is locked in or could change before closing.
- Interest rate. How much interest you will pay the bank as a percentage of your loan. You should also pay attention to if this rate is fixed or variable (Note: Also pay close attention to the APR, which is discussed in the ‘Comparisons’ section below).
- Monthly principal and interest. This how much you will pay on your home loan each month that will cover the principal loan amount and bank interest.
- Estimated total monthly payments. This is how much you’ll pay each month for your loan. At minimum, your payment will Include loan principal and interest, but can also include property taxes, insurance, and possibly other fees like HOA dues.
- Estimated taxes, insurance and assessments. It’s possible that these items will not be in escrow and therefore, not included in your payment. In this case, you will have to pay these fees yourself, aside from your monthly loan payment.
- Estimated cash to close. This is the amount of money you’ll need to bring at the time of closing.
These are just a few key terms you should understand to start. If you want to understand all sections and terms on your Loan Estimate use the CFPB’s interactive tool called the Loan Estimate Explainer. This tool allows you to hover over sections of the document to get clear explanations of any sections or terms you don’t understand.
How to compare estimates from multiple lenders
Perhaps one of the best things about the Loan Estimate is the ability to compare estimates from multiple lenders. The template’s language is clear and uniform so you can quickly and easily identify areas where you should be comparing rates and terms.
Before you compare your Loan Estimates, make sure you are getting estimates for the same kind of loan from each lender. For example, if you ask one lender for rates and terms on a 15-year mortgage and another for a 30-year mortgage, you won’t be comparing apples to apples.
Next, there are certain sections you should examine to make sure you are getting the best deal from your lender:
On page 3 of your Loan Estimate, you’ll find a section labeled “Comparisons.” It contains a simple table with figures that you’ll want to use for comparing estimates. Once you get Loan Estimates from all the lenders you’re considering, put each lender’s comparison table side by side.
First up, you’ll see a section labeled “In 5 years,” showing how much you’ll pay for your home in the first five years. The first number in this box tells you the total you would have paid in principal, interest, mortgage insurance, and loan costs over the first five years of your home loan. Right below this number, you’ll see the amount of principal you would have paid off as well.
Next in the table, you’ll see the annual percentage rate (APR.) This figure is key because it takes into account all the fees you’ll pay for to purchase your home. Think of it as the bank’s interest rate plus any points, mortgage broker fees, and other charges that you might pay for your loan.
Finally, at the bottom of the table, you’ll see total interest percentage (TIP) will be right under the APR section. It represents the total amount of interest you’ll pay over the lifetime of your loan.
Under the “Costs at Closing” table on page 2, you’ll see a section labeled “Estimated Cash to Close.” For more details on how these numbers were calculated, look at “Calculating Cash to Close” at the bottom of page 3.
This section goes over the cash needed to settle up at the closing table i.e. what you need to bring to closing. Remember, this figure should be not changed drastically from the Loan Estimate once you get the final closing disclosure.
Fees that cannot change at closing include lender fees, other service fees, transfer taxes, and commission fees due to mortgage brokers or affiliates. Fees that can change 10 percent in either direction are recorder fees or service fees related to third-party providers.
If closing costs changed substantially, you may be eligible for a refund of costs that go beyond the allowable limits.
The smartest way to buying a home comes down to understanding your options and choosing the best one. You may feel tempted to go with the nicest lender, or the one with the most brand recognition, or where you already bank.
However, if you don’t compare actual loan terms, you could be forgoing the best possible outcome for your home purchase. Use the Loan Estimate for what it was designed for: comparison shopping to get the best deal on a home loan.