Loan Estimate Guide for First-Time Homebuyers
When you’re pre-approved for a mortgage, it’s crucial to compare rates from different lenders. However, knowing how to compare these rates is even more important. This is where a loan estimate comes in handy.
Understanding a Loan Estimate
A loan estimate is a document provided by lenders that outlines key details of your loan, including the estimated interest rate, loan costs, closing costs, and other expenses associated with buying a home. This standardized three-page document, issued by the Consumer Financial Protection Bureau (CFPB), helps you compare offers from different lenders.
How to Obtain a Loan Estimate
To receive a loan estimate, you need to provide the following information to the lender:
Your name
Your income
Your Social Security number
The property address
An estimated value of the property
The desired loan amount
For a more detailed estimate, include your debt information, specific loan type, and down payment amount.
Reading a Loan Estimate
Here is an example of what page 1 of a loan estimate looks like. This picture is directly from the CFPB’s website.
Page One
Borrower and Loan Information
Borrower Information: Your name and the property address.
Loan Information: The loan term (typically 15-30 years), the loan purpose (e.g., buying a home), the loan product (fixed or adjustable rate), loan type, loan ID number, and whether the interest rate is locked or subject to change.
Loan Terms
Loan Amount: The amount you’re borrowing.
Interest Rate: The rate at which interest will be charged.
Monthly Principal & Interest: Your basic mortgage payment excluding taxes and insurance.
Prepayment Penalty: Any fees for paying off the loan early.
Balloon Payment: A large payment due at the end of the loan term.
Projected Payments This section details your expected monthly payments over different periods, typically split into two parts (e.g., Years 1-7 and Years 8-30), including:
Principal & Interest: Your monthly payment towards the loan balance and interest.
Mortgage Insurance: Required if your down payment is less than 20%.
Estimated Escrow: Monthly payment for property taxes and homeowners insurance.
Costs at Closing This section summarizes the estimated closing costs and the cash needed to close, which include loan costs, other costs, and any lender credits.
Page Two
Here is an example of what page 2 of the loan estimate looks like. This picture is directly from the CFPB’s website.
Loan Costs
I will break these closing costs down one by one since these are the most important costs to look at when choosing a lender.
Box A. Origination Charges: These fees are for processing the loan, including points, application fees, and underwriting fees. Please keep in mind that lenders sometimes call items in this box different names but they are all costs that are paid to the lender. This box alone is the most important box to look at in my opinion when you are comparing lenders. What you can find is shocking. Below is a hypothetical example of what you may find:
Lender A claims they are offering a 5% interest rate. Although they aren’t clear on what the cost of that rate may be, so you go to the loan estimate to find out. In Box A you see they are charging you $5,000 in points for that 5% rate. Woah, that’s more than you were anticipating and more than you have allocated for this home purchase. You decide to get a second opinion from another lender you know.
Lender B is offering you a 5% interest rate and they state that they can do it for $2,500 in points. That’s more what you are looking for and now you know that Lender B is a less expensive lender. Just by getting a second opinion you saved yourself $2,500 on your home purchase. Wahoo!
Box B. Services You Cannot Shop For: Costs for services like appraisals, credit reports, and flood determinations, which the lender arranges.
Box C & D. Services You Can Shop For & Total Loan Costs: Fees for services like pest inspections, surveys, and title insurance, which you can shop around for.
Other Costs
It’s important to note that these costs below are not going to differ much between lenders. They are all costs from outside services such as taxes, insurance (which you shop for), or transfer taxes which are government set fees.
Taxes and Government Fees: Costs for recording the sale and transferring the deed.
Prepaids: Upfront payments for homeowner’s insurance, mortgage insurance, prepaid interest, and property taxes.
Initial Escrow Payment at Closing: Funds set aside to establish your escrow account for future payments.
Other: Miscellaneous costs not covered in the above sections, such as the owner’s title policy.
Total Closing Costs The total of all loan and other costs, minus any lender credits, gives you the final closing cost amount.
Page Three
Here is an example of what page 1 of a loan estimate looks like. This picture is directly from the CFPB’s website.
Additional Information This page provides details about your lender, including contact information and licensing details.
Comparisons This section shows:
In 5 Years: The total amount paid in principal, interest, mortgage insurance, and loan costs over five years.
Annual Percentage Rate (APR): The total loan costs over the loan term expressed as a rate.
Total Interest Percentage: The total interest paid as a percentage of your loan amount.
Other Considerations Important loan details such as appraisals, assumption options, homeowner’s insurance requirements, late payment policies, refinancing conditions, and loan servicing arrangements.
What to Watch Out For
Ensure your loan estimate matches the CFPB’s standard format. Be cautious of lenders who might underestimate or overestimate costs to make their offers look more appealing. Sadly this is a fairly common practice in our industry so be sure to look at lenders reviews, you will find out very quickly if you can trust a lender or not. Always aim for accurate figures for better budgeting.
How to Compare Loan Estimates
Focus on the top left section of page two, where loan costs and services you cannot shop for are listed. The total amount of origination charges and unshoppable services gives you a clear picture of what the lender is charging for your interest rate.
Reducing Loan Costs
You can negotiate loan costs by opting for a higher interest rate in exchange for lower upfront fees or by paying more upfront to secure a lower interest rate and monthly payments. Discuss these options with your lender to find what works best for you.
Final Thoughts
Understanding a loan estimate and comparing offers from multiple lenders will help you make an informed decision. Always focus on the most critical variables: loan costs and interest rates. This approach will make it easier to choose the best loan for your needs. Before committing, compare rates from several lenders to ensure you get the best deal possible.
