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Mortgage Costs

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This lesson covers the costs you incur when you get a mortgage loan.

Understanding these costs will make you an informed buyer, much better equipped to choose the mortgage package that best meets your needs.

Interest Expense and Points

The most important mortgage-related costs are interest expense and discount points.

  • Interest expense. Interest expense is the amount paid on mortgage debt. The amount of interest expense is determined by the interest rate. For example, if you borrow $100,000 at a 7% interest rate, you would pay $7,000 in interest in the first year.

  • Discount points. Discount points (also referred to as points) are an upfront fee paid to the lender, in order to lower the interest rate on the loan. One point equals 1% of the loan amount. Thus, if you get a $100,000 mortgage at 2 points, you will need to pay 2% of the loan (i.e., $2,000) at closing. Since you are required to pay $2,000 upfront, you actually only receive $98,000 from the lender.

Normally, paying discount points is voluntary. You can pay discount points upfront and get a lower interest rate, or you can avoid discount points and pay a higher interest rate.

Should you pay discount points? The answer depends on many factors (the interest rate, the number of points, the duration of the loan, etc.). This is an important consideration in the choice of a loan - one that can save you thousands of dollars. We show you how to sort it all out in the case study on points.

Prepayment Penalty

A prepayment penalty is a fee charged by a lender when the borrower repays the loan before the end of its term. Prepayment penalties exist to compensate the lender for interest and other charges that would otherwise be lost.

Normally, prepayment penalties are only charged during the first 3 to 5 years of the mortgage. And loans with prepayment penalties usually have lower interest rates than loans without prepayment penalties.

Other Mortgage-Related Expenses

In addition to interest rate, discount points, and prepayment penalties, home buyers may incur other mortgage-related costs, which are paid at closing. Some are negotiable and may be avoided altogether.

  • Origination fee. This is an upfront fee paid to the lender at the time of closing. Like discount points, the origination fee is stated in the form of points. Thus, if you get a $100,000 mortgage with a 3-point origination fee, you will need to pay 3% of the loan (i.e., $3,000) at closing. Since you are required to pay $3,000 upfront, you actually only receive $97,000 from the lender. Unlike discount points, the interest rate on the loan is not affected by the origination fee.

  • Appraisal fee. This covers the services of a professional appraiser, who estimates the fair market value of the property. Usually non-negotiable.

  • Attorney fee. An attorney may handle the settlement transaction for the lender. This fee covers those services.

  • Credit report fee. This is a fee paid to a credit-reporting company. Its purpose is to verify the financial status of the borrower. Usually non-negotiable.

  • Document fees. These fees cover the preparation of documents and other papers required to complete the property transfer.

  • Homeowner's insurance. This protects the lender and the buyer in the event that the home is damaged by fire, weather, or some other event. The premium is often made part of the monthly mortgage payment.

  • Private mortgage insurance (PMI). This protects the lender, if the buyer defaults on mortgage payments. It is often required for loans with small down payments (less than 20% of the home's fair market value). Buyers can avoid this expense by increasing their down payment.

  • Property survey. A property survey defines the exact location of a house and its boundaries. Many lenders require that a property survey be conducted. However, lenders will sometimes accept the seller's old survey in lieu of a new survey, which saves the expense of conducting a new survey. Check with the lender.

  • Recording fees. These are fees imposed by local juridictions for recording the new deed and other documents.

  • Termite inspection. A termite inspection is often recommended and may be required in some parts of the country.

  • Title insurance. Many lenders require title insurance on the property. This protects the lender against liens and ownership problems that arise after the mortgage is purchased. Since this protects only the lender, you should get separate coverage to protect yourself, as well. The cost to you is often greatly reduced if you buy title insurance at closing.

  • Title search. Most lenders require a title search to verify that the property has no liens against it.

Next Steps

As we move through the remainder of this tutorial, we will talk more about these cost factors. We will show you how to collect cost information efficiently, and how to use the information you have collected to identify the mortgage plan that best meets your financial needs.