For borrowers to receive a clear and detailed guide of all the costs and fees of taking a mortgage, the law requires mortgage companies to provide an estimate of those charges. This was originally called a good-faith estimate (GFE), but the “Loan Estimate” was created by the Consumer Financial Protection Bureau (CFPB) in 2015 to differentiate it from the Good Faith Estimate. Today, a GFE is only used for reverse mortgages, a type of mortgage where the lender pays the homeowner a monthly amount that reduces the equity in the property. The simpler loan estimate is used for all purchase mortgages.
The loan estimate must be given to the borrower within three days of completing the mortgage application process. Because the loan estimate form is standardized and should be the same for all lenders, you can shop around with different lenders for the lowest mortgage rates. This helps the borrower achieve the best rates and terms for the loan. The loan estimate is usually only valid for 30 days but can be extended to 45 days if newer income documentation is presented to the lender.
What is Included in Your Mortgage Loan Estimate?
A loan estimate example includes a summary of the monthly payments and any other regular costs. The breakdown is principal, interest, taxes and insurance or PITI. If mortgage insurance is also required, that will be part of the loan estimate too. The closing costs to be paid and the loan terms, such as number of months, prepayment penalties and interest rate will be on the estimate.
The loan estimate is not binding because interest rates and other costs can change. It’s simply a guide for an approximate total of the mortgage costs. In addition, receiving a loan estimate does not mean the borrower automatically qualifies for a loan. It only shows what the lender expects to offer you. Should you decide to move forward with the loan, you will be asked for additional financial information that will be used to determine loan eligibility.
Interest Rate and Annual Percentage Rate (APR)
An interest rate is the cost of borrowed money and is always expressed as a percentage. For example, if John and Betty have a 5.5% mortgage on their home they will pay 5.5% of the loan amount (not the home price) per year in interest. On a $300,000 home, they would pay $16,500 in interest in year one. In the second year, they would still pay 5.5% interest, but it would be on a smaller loan amount due to the principal paydown that occurred in year one.
The Annual Percentage Rate or APR, is the actual amount paid, including the interest, closing costs and other fees associated with acquiring the loan, such as an origination fee, mortgage points, private mortgage insurance and underwriting fees. It’s a more accurate representation of the total mortgage cost than just the interest rate and that is why the law requires mortgage companies to list the APR along with their interest rates.
Detailed Monthly Payment Estimate
A detailed monthly payment estimate should include the principal and interest, monthly and annual taxes, monthly homeowners association (HOA) dues, insurance and PMI. In addition, it should note the loan term, interest rate, whether the rate is fixed or adjustable, the purchase price and down payment amount.
Itemized Closing Costs
The good faith estimate must include itemizing all fees and costs associated with the loan. These include:
- Title Insurance (varies by state, typically 0.1%-2% of the purchase price)
- Loan origination fee (about 1% of the loan amount)
- Real estate appraisal ($300-$800 for the typical single-family home)
- Property taxes (2-3 months escrowed, the amount depends on home value and tax rate)
- Escrow or closing fee (1-2% of the sales price)
- Homeowners Insurance (varies, usually 10-20% of the annual premium)
Prepaid Interest
Many borrowers don’t realize it, but the lender requires interest to be paid on a loan at closing rather than at the time of the regularly scheduled payment. The borrower will pay the interest due from the day of the closing to the end of that month. The following month, no mortgage payment is made; however, the month after that, the first regular payment is due.
For example, John and Betty close on a home on September 25. At the closing, they must bring six days of prepaid interest to cover the period from Sept. 25 to September 30. They have no mortgage payment due in December and their first mortgage will be due in January. In that way, mortgage payments are always one month in arrears, but the additional days from closing until the end of the month are paid.
If a borrower chooses to take a mortgage point to reduce the interest rate, that amount is included at closing as prepaid interest.
Escrow Expenses
Escrow expenses are the fees that a borrower pays the closing agent during the home closing. The expenses include recording the deed, distributing funds to all appropriate parties and paying the title company or attorney who holds the closing. Other paperwork and actions are also involved. For example, the closing agent must send all the signed paperwork to the mortgage company for final approval before the closing is official. A few weeks after the closing, the closing agent will send the buyer the officially recorded deed by the county.
Escrow expenses can be paid by either the buyer or seller or both can split the costs.
Importance of the Loan Estimate for Borrowers
The significance of the loan estimate for borrowers cannot be stressed too much. If borrowers were not given a complete and detailed estimate, they would have no idea what their monthly payments would be, nor would they know how much money was needed to bring to closing. In essence, they would be operating in the dark and at risk for fraud or not having sufficient funds to close on the home.
How To Get a Loan Estimate
It is quite easy to get a loan estimate. Once you’ve found a home, you can contact multiple lenders for loan estimates. Having more than one loan estimate can save you hundreds of dollars annually on the interest rate and terms.
No written documentation is required and you do not need a signed purchase agreement to get a loan estimate. The lender is required to give you a loan estimate once you’ve submitted the following six pieces of information:
Name, income, social security number, address of the home you plan to purchase, estimate of the home’s value and the loan amount needed.
It’s also a good idea to submit information on the property taxes and condo or homeowners’ association dues, although the lender can look these up online if you don't know them.
Conclusion
Every prospective homeowner wants to find the best home loan rates and the loan estimate is an important way to quickly secure low mortgage rates and terms. It’s not always easy to find the lowest mortgage rates because rates can change almost daily and one must compare fixed rate to fixed rate or adjustable rate to adjustable rate of the same term. You will also want to ensure that the different rates and terms are for the same type of mortgage, Conventional, VA, FHA or USDA.
Remember that the loan estimate is merely the first step of the long loan process and is not the same as getting a preapproval or prequalification. And finally, the loan estimate is just that- an estimate and the final numbers could be lower or higher. Most mortgage lenders are careful to err on the high side so the borrower is relieved to see a lower amount that needs to be brought to the closing table.