Homeowners Insurance is not only an essential support for you as a homeowner, it is also an unavoidable part of a mortgaging process. You are required to have homeowners insurance on the property you are mortgaging, no mortgage will close without it. The lenders’ concern is obvious – your property is the collateral of their expenses, they are not ready to give it all up to rain or fire.

Talking about rain, water, and particularly flooding.  Surprisingly enough, it was not until Hurricane Katrina struck, that the whole nation woke up to realize that regular insurance policies did not cover damage from floodwaters (nor hurricanes, nor earthquakes). Too many were unaware that the circumstances required a special federal flood (hurricane, earthquake) insurance policy in addition to their regular one. Moreover, certain carriers did (and some still do) take advantage of this unawareness to avoid payment by claiming the damage was due to flooding even when it was not. Nowadays, flood-related insurance can be required in certain areas, along with a regular policy, to close a mortgage. Generally, your broker should be able to provide you with this information, but you can also do some research yourself. The official on-line resource is the page of the U.S. Department of Homeland Security. You can find out if you are in a risk zone for flooding and the degree of the risk, as it determines the necessity of the insurance. Because there are policies that cover water damage from hurricanes but not from floods, make sure you understand the subtle differences that can disallow one type of damage while allowing for something similar. Check out other risks of your area – it will help you decide what kind of insurance you will want for your property because the main purpose of any insurance is to compensate for losses, not just meet a paper requirement at closing.

The estimate of the insurance charge at closing appears as #11 on the Good Faith Estimate and a little further again on Page 3 as one of the Charges that can change at settlement. The lender may recommend some carrier to you, but it is only a recommendation. You are expected to shop for Homeowners Insurance yourself, which immediately gives you a big variety of choices and options. The most important characteristics of insurance to look at are the deductible and the coverage. The deductible is an unclaimed amount that the borrower pays himself to repair whatever damage resulted from an insured event. It is a set amount and if the repairs cost more than the deductible, you can claim the difference. The higher the deductible – the lower the premiums. The carrier expects that you will be able to pay for most repairs yourself, so they do not need so save really much for you. Do not disappoint them, for as soon as you start claiming even small amounts, even if they do exceed the deductible, you should expect a raise in premiums. Having a high deductible may seem a little bit too costly at a first glance, but experiments have proved, that if one has a high deductible and low premiums policy, he may have to pay for removing a tree fallen on the roof of his house himself, but the amount he had saved on the difference between his low premiums and the imposed otherwise high premiums, compensates for a very big part of the expenditure. In fact, in most cases it turns out cheaper than paying higher premiums all the way and have the carrier compensate for the costs. Be careful not to overestimate your financial potential, though – if something happens, you really have to be able to pay. Your lender may also have a requirement about the size of the deductible, so clear this up before you shop for insurance.

The coverage is always a pain. You must read thoroughly every item that is covered by your policy and make sure it covers everything you need. Some companies try to sneak certain issues, such as mold or dog bites, out. But it is not only the list that is important, but also the degree of coverage. “Guaranteed replacement cost coverage”, that pays the total bill to rebuild your property regardless of the price, is very hard to come by, and where it is available it is very expensive. The other levels of coverage are “actual cash value” (lowest coverage),”replacement cost” and “extended replacement cost”. The key is finding out what coverage you will have if your house is destroyed. A good policy should also take inflation into consideration.  Do not forget to pay special attention to flood/earthquake/hurricane insurance. You have to purchase those from the federal government; private companies do not provide this sort of service.

You may also consider a Personal Umbrella Liability Policy. This would extend the coverage even further at a price that many can afford. It is called an umbrella because it is carried over all other liability insurance and is used for a catastrophic loss when primary liability insurance is exhausted or for claims currently not covered. It is exceptionally useful if you (of course, God forbid, but still…) get involved in a car accident or get sued. Say, you fall asleep driving and cause an auto accident with a couple of cars, a driver and passenger in each car and everyone gets hurt and cars are totaled… It is not very likely that your regular liability limits will be enough to pay for everything and everyone. What if they sue you? The court can take everything except one car, basic household furnishings, the value of your house over $150,000 (which means if your house is valued higher you might have to sell it), and up to 30% of your wages for the rest of your life… or the umbrella insurance can pay your way out of this financial mess.  It also may cover some more exotic items, such as an accident while driving a golf cart at a golf course. Usually this “umbrella” is available to customers who insure both their auto and home with the same insurance company.  Beware, though, because some companies nowadays sell a product called “excess liability” policy, which is not a real umbrella and has a narrower coverage. Be sure to find out exactly what you’re getting.

For people who are not into “extras” very much, there is some advice on how to reduce the regular insurance premiums:

-          Even if you do not want Umbrella Insurance, you may still consider buying your auto insurance and homeowners insurance from the same carrier. These companies want as much of your business as they can possibly get, so many offer discounts to their customers who have more than one policy with their company. For you it may also mean less hassle paying the two premiums, as they will be billed to you together.

-          You may receive some discounts for being loyal to the company; usually, if you stick with them for 5 or more years.

-          Appropriate precautions to safeguard your home will decrease your premium, as well as actually make your house safer: deadbolt locks, smoke detectors, home security systems, burglar-proof bars on your windows, if you can tolerate the look of them, will reduce your premium a lot.

-          Here is one for free – do no smoke! Many homeowners are not aware that they can reduce their insurance premium if they stop smoking. Smoking cigarettes is one of the leading causes of home fires. Insurance companies will often offer a discount if no one within the home will be smoking as this offers less risk of a fire happening in your home.

-          Inspect all walkways regularly to make sure they are properly lit and free of obstacles. Preventing other people from being injured while on your property, you save yourself from a premium increase triggered by claiming.

The insurance requirements for buying a home may vary from lender to lender, but most of them require that the premium be paid for the first year at closing. If the borrower is starting an escrow account, an additional amount equal to several months’ premiums must be paid to fund the account.

I have always been wondering why we have two different disclosures (TIL and GFE) to serve one and the same purpose… Why can’t it be just one form with all a borrower has to know? The funniest thing, though, is the fact that both The Department of Housing and Urban Development (HUD – the author of the GFE/HUD1 duo) and the Board of Governors of the Federal Reserve System (the creator of the Truth in Lending document) recommended jointly to the Congress, among other quite sensible things, I am citing:

Combining and simplifying RESPA and TILA disclosures that are provided to consumers; and requiring information about the loan originator’s role and any requirements for escrow accounts and private mortgage insurance.

The depressing part here is that the report is dated July 17, 1998. The forms have not been combined, only the GFE and HUD-1 have been modified yet to become mandatory in 2010. The Truth in Lending disclosure is still in the queue. The recent activity of the Federal Reserve Board indicates that the problem is not ignored. The Press Release dated July 23, 2009 informs that The Federal Reserve Board proposed “significant changes to Regulation Z (Truth in Lending) intended to improve the disclosures consumers receive in connection with closed-end mortgages and home-equity lines of credit (HELOCs)“.

… the key word being “closed-end”. Any Truth in Lending Disclosure carries an APR as the strategic characteristic of a mortgage, and an APR, at least how it is calculated and presented now, makes sense only for closed-end mortgages and suffers from quite a number of issues that are described in my article. The overall big issue of an APR as such, challenges the usefulness of the Truth in Lending Disclosure.

Your loan officer or mortgage broker is required to provide you with the Truth in Lending Disclosure Statement within three business days of the date that you apply for your loan. Let’s have a look what you may get, for example, here. Truth in Lending disclosure statements vary from lender to lender. There may be other specific to your mortgage sections included, such as a Balloon Payment, or a Credit Life/Credit Disability section. Many entries are provided with descriptions or are quite self-explanatory. I want to draw your attention only to those, that are either unclear or can be misleading.

The top entries (Creditor, Mailing Address, Loan Number, Applicant(s), Property Address, Preparation Date) are obvious. Then comes the notorious APR, described on the form as “The cost of your credit as a yearly rate”, which is rather a brief explanation of a very complicated matter. I refer you again to my article for details on that.

The new rules defined in the amended in 2008 federal Truth in Lending Act and effective from July 2009, oblige the lender to provide the borrower with an updated TIL if the APR changes by more than 0.125 percent. The APR can change due to a change in the interest rate, loan program or loan-related fees, the last being the most common case. More accurate information is a good thing to have, but beware: it comes with a “bonus” – a three long days’ wait. The same TILA rules now that the loan cannot close for at least three days after the borrower receives the new TIL, and that’s in addition to the seven days’ wait after the initial TIL! The purpose of these deliberate delays is to give the borrower some time to analyze the conditions and take an unhurried decision. Emergency situations, for example, if the borrower needs to refinance as soon as possible and avoid foreclosure on his home, are expected to be resolved through modification or even waiving of the waiting period. The borrower has to provide the lender with a dated written statement that describes the emergency, specifically modifies or waives the waiting period, and bears the signature of all the consumers who are primarily liable on the legal obligation, in handwritten form. Printed forms for this purpose are prohibited. However, it is still totally up to the lender to allow the expedition of the closing. If the lender refuses, the situation may become quite grief for certain borrowers, for example, when foreclosure or delay penalties are involved. Borrowers should also bear in mind another possible delay – the appraisal. It’s very likely that the lender will not order the appraisal until the last TIL review period is over and the borrower has paid the appraisal fee.

FINANCE CHARGE – The dollar amount the credit will cost you, i.e. the total of interest payments plus the total of prepaid financial charges. The estimated amount of interest paid over the life of the loan is based on the assumption that the loan will run to its original term, say, 30 years, that you will make no extra payments, that the interest rate will stay intact throughout all the 30 years, etc… Such ideal conditions are not met very often in real life, where the average age of a mortgage is around 8 years. It also includes prepaid financial charges that can be found on the GFE. The estimates of charges paid at closing had been so inaccurate for years, that the HUD finally redesigned the Good Faith Estimate disclosure form and introduced more strict lenders’ estimation reliability requirements. For more details read this article. Appraisal and credit report fees are specifically excluded from this calculation.

AMOUNT FINANCED – The amount of credit provided to you or on your behalf. This is a really confusing number. There is little, if at all, practical use of it to you as a borrower. It is calculated by subtracting prepaid financial charges from the amount of your loan. If you borrow, say, $100,000 and pay $3,000 for points, the Amount Financed is $97,000. It is rather a technical parameter for calculating the APR of the mortgage. Most importantly, you should understand that it does not make the loan balance lower – you still get $100,000 (not $97,000) for your purchase, and that’s exactly how much you have to pay back plus all the attendant fees. Financing some of the prepaid fees with the loan adds the amount to the original $100,000, making the balance higher.

TOTAL OF PAYMENTS – The amount you will have paid after you have made all payments as scheduled. The estimate is built again on the presumably unchanged conditions throughout the whole life of the loan running to its full term.

PAYMENT SCHEDULE – needs, probably, one remark, that is sometimes to be found in footnotes on the form itself. Amount of Payments includes Principal, Interest, Mortgage Insurance (if applicable) payments, but excludes property taxes and insurance, even if they are escrows.

DEMAND FEATURE – TIL only states whether your mortgage has a demand feature; it does not explain what exactly the feature implies. The details of the demand feature are to be found in your contract. It may bear the acceleration clause, which stipulates that in the event you violate a contractual obligation, the lender has the right to “call” the loan – demand its payment in full immediately. It may have the due on sale clause, which stipulates that if you sell the mortgaged property, the loan becomes immediately due and payable in full. The purpose of this clause is to protect the lender against rising interest rates.  If you sell your house and just pass the loan onto the new owner, the lender may lose money if interest rates have climbed. With this clause, the lender can rearrange the loan with the new homeowner at new terms and rates. The examples above are sensible demand clauses. However, there have been cases when lenders got tempted and abused the feature by including something called simply the demand clause claiming that the lender can demand repayment of the loan in full at any time for any reason. Such a clause covers the two circumstances mentioned above, as well as gives the lender practically unlimited power to push the borrower around in many ways, a higher interest rate under threat of calling the loan being one of them.  Luckily, such outrageous entries in contracts do not happen very often, but it’s always better to keep your eyes open and have a closer look at the item when reading the document.

FILING FEES – An estimate of the amount you will have to pay to have the mortgage documents officially recorded; charged at closing.

PREPAYMENT – is often penalized. If the word “may” is marked on your form, it means that you will be penalized for principal payments made ahead of the regular schedule. It is sort of weird to oppose the word “may” to “will not”, but they must have had their reasons. Most importantly, it should not confuse you or give you a feeling, that the penalty is more likely not to be imposed if it’s “only may”.  If the lender is not planning any penalties, he will make it clear by marking “will not”.

Now, isn’t it too many issues for a one-page document? Designed to complement the GFE and assist a borrower’s choice of a mortgage plan and provider, TIL, on the contrary, ends up being quite confusing and in many cases misleading. I won’t say “put it aside and never look in it”, because it discloses certain borrower’s responsibilities you must be aware of, but I will advise against trusting it too much as a comparison tool. It bears the same issues as the GFE – the rates provided are obsolete the next day and if you get quotes from several lenders on different days, it makes the comparison based on the TILs inaccurate.

The bottom line: use both the TIL and the GFE to make your choice, never rely only on one of them; and remember – they both are just estimates. When you sign the TIL at the bottom of the page, it is neither a contract nor a commitment to lend – it only indicates that you received the document on a certain date.

The recently introduced new Good Faith Estimate (GFE) form triggered certain changes in the settlement documentation chain. Its long-time associate the Housing & Urban Development Settlement Statement (HUD-1) form has undergone a makeover, too. The guidelines for the usage of both documents went into effect on January 16, 2009, but they will become mandatory only on January 1, 2010.

Unlike the GFE that provides only the estimation of the settlement costs, the HUD-1 describes the real deal. The new HUD-1 form has clear references to the corresponding items in the GFE and a special section, where you can compare the GFE promises and their HUD-1 implementations. The Statement itemizes all charges imposed both on you as a borrower and the seller for the real estate transaction. It gives each party a complete list of their incoming and outgoing funds. Fees associated with the transaction but paid prior to closing are also included. They are normally marked “POC” for Paid Outside of Closing. RESPA states you should be given a copy of the HUD-1 at least one business day prior to settlement. In real life, however, entries may still be coming in a few hours before closing. The form is filled out by the settlement agent who will conduct the settlement, so make sure you have the name, address, and telephone number of this agent if you wish to inspect the form prior to closing. Have the agent go through the details with you and do not hesitate to ask about any suspicious increase (or decrease) from the estimate, about any charge you do not understand. Do not feel shy to find out exactly what you are paying for.

Before January 1, 2010 you may still be provided with old GFE and HUD-1 forms. These forms bear their old issues, incomprehensibility being one of them. If the potential lender only cared to offer you the old standard forms, you may give the whole deal a second thought. Note, if the GFE presented to you is a new standard, the following HUD-1 must also be new. The old GFE couples with the old HUD-1 only.

What good is the Good Faith Estimate you received from your potential lender? Let’s see…

At first sight, the information provided seems gold – origination fees, appraisal fees, credit report… you name it! And then you get several Estimates from different lenders, and compare, and think that you have made a fair choice until… well, actually, the closing. To many people it came as a shock – the actual cash charges happened to be a lot higher than any GFE had ever told them. The problem was, and still is for the old forms, that the document bore no clear indication of the possible changes in the prices. People relied too much on numbers that were just estimates, sometimes highly inaccurate ones. Moreover, no penalty was imposed on lenders, who intentionally provided inaccurate numbers. Originally intended to help a homebuyer compare mortgage offers and select a program best suited for his particular situation, the document ended up in being confusing and, what is worse, misleading. For years, the prices and charges quoted in too many GFEs had little to do with the real charges that borrowers had to face at closings. Tempers rose, and finally the government paid attention – the new Real Estate Settlement Procedures Act (RESPA) guidelines went into effect on January 16, 2009. The new Good Faith Estimate (GFE) and Housing & Urban Development Settlement Statement (HUD-1) can already be used, but become mandatory only on January 1, 2010.

A fair question – what difference does it make if it says on the paper in block letters “NO WORD OF TRUTH HERE”, I’ll just throw it away – gets a hopefully effective and efficient answer in the new RESPA. The year of 2009 allows lenders to choose which forms to use, but the usage of the new forms also implies, that the lender has to comply with the other new requirements, namely:

• Use the new standardized Good Faith Estimate form (GFE). Unlike the old form, which was rather a flat list of items, the new one has a clear structure of categories, no “junk fees”;
• Provide a clear summary of the loan terms and total settlement charges on page one of the GFE. Tests proved that the summary is actually useful for comparison-shopping. However, you should always bear in mind the unavoidable issues of all mortgage price quotes – they get outdated within 24 hours, mainly the Interest Rate & Points if they are not locked. You cannot lock them with every lender you comparison shop. Even if all lenders provide you with perfectly accurate GFEs, but all of different dates, the comparison results may still be quite misleading;
• Provide more accurate settlement services cost estimates on the GFE. The costs subject to changes are differentiated from the unchangeable costs, there is a special section explaining which charges can change (and how much) and which cannot;
• Ensure borrowers are aware of final loan terms and costs at settlement
• Clarify HUD-1/HUD-1A instructions
• Clarify HUD’s current regulations concerning discounts

The new GFE also offers a special tradeoff table section, where the lender can suggest a couple of alternative mortgage plans based on the borrower’s situation. The tests conducted by HUD proved this section very useful for borrowers. Unfortunately, lenders are not required by law to fill it out, so if you want this comparison information, you have to ask for it explicitly.

Now, how do you know if the GFE you have received is an old or a new form? Does it look like this or like that? The former is the old form, and the latter is the new one. It is more or less clear what to expect from a lender with a new form, as it has already chosen to comply with all the other regulations accompanying the new GFE and HUD-1. An old-standard GFE, however, still bears its issues: poor comprehensibility, possible inaccuracies due to many reasons including lack of legal liability for errors. If you choose to commit yourself to an offer described by an old form, I would suggest two steps to prevent too much disappointment and stress at the closing:

1. ask the lender to provide you with the HUD-1 form at least 1 day prior to closing, not at closing itself – you have to have time to compare the HUD-1 and the GFE and prepare questions over everything that seems unclear;
2. make it clear to the lender, that if the actual charges at closing happen to be a lot higher than declared in the GFE, you will NOT close.

No matter if the form is new or old, it is an estimate and should be treated as such. Certain unintentional inaccuracy may occur, too, as, for example, large lenders operating nationwide are not always familiar with local customs, for example regarding the buyer’s cost for title insurance. In one county it is customary for the seller to pay for title insurance, while in the adjoining county the buyer pays it. However, you personally do not always have to follow the customs of the area, for your mortgage you can negotiate who pays what and on what terms.
And finally – close at the end of the month. As all mortgage payments are due on the first of the month, you can avoid or reduce the prepaid interest due by closing on or near the last day of the month.

As many other borrowers, you probably got deceived by the APR’s apparent similarity to the interest rate and assumed that “locking the rate” means locking all the rates involved. Unfortunately for borrowers, that is not the case. The APR does not only include the interest rate and the points, which do get locked, but also the closing costs, origination fees and other cash-based parameters, which do not get locked, ever. When you lock the rate, you lock the interest rate and the points only. In the time between the locking and the closing, the lender is free to change all the other included into the APR fees at will. Some lenders are not shy to exercise the right. An increased APR means that at closing you will have to pay more than the original estimation of charges. It is always hard to say whether it originally was an intentional underestimation of costs presented by the lender in an attempt to attract a customer, though.