Lenders are required to provide you a Loan Estimate that outlines key mortgage terms including your interest rate, closing costs and loan features within three business days of submitting your mortgage application. The Loan Estimate is supposed to help you hold lenders accountable and make sure that your mortgage terms do not change significantly from the beginning to the end of the mortgage process.
While the primary purpose of the Loan Estimate is to help you identify an increase in your mortgage rate or closing costs, in some cases the actual costs you pay are lower than the costs on the Loan Estimate. Paying lower closing costs than you expected is usually a good thing but it is important to understand why this can happen when you get a mortgage.
There are several possible reasons why the closing costs you are actually required to pay when your mortgage closes are lower than the cost figure presented on your Loan Estimate. We review the reasons below and explain what to do if the costs you pay are different than the costs on the Loan Estimate.
One of the most common reasons why your actual mortgage closing costs may be lower than the Loan Estimate is because you finance a one-time mortgage insurance fee by adding it to your loan amount instead of paying for it out of pocket. The FHA, VA and USDA mortgage programs require borrowers to pay an upfront mortgage insurance or funding fee, which is listed as a closing cost on page two of your Loan Estimate under "Services You Cannot Shop For."
Review How to Use a Loan Estimate
In most cases, borrowers add the mortgage insurance fee to their mortgage instead of paying for it with their own funds, which significantly reduces the closing costs you are required to pay at closing. This upfront fee can be thousands of dollars, depending on your mortgage amount and other factors, so financing it makes a big difference in your closing costs. You still pay the fee at closing with proceeds from your loan but instead of paying for it with money from the bank or another source, you pay for it over time as you make your monthly mortgage payments.
To confirm how the one-time mortgage insurance or funding fee is handled, you should look at the bottom right of page two of your Loan Estimate under "Calculating Cash to Close." The second item listed should be "Closing Costs Financed (Paid from your Loan Amount)." That figure should be negative and equal the upfront mortgage insurance fee plus any other costs you are financing.
The "Closing Costs Financed (Paid from your Loan Amount)" figure is negative because it is added to your loan amount instead of you paying that cost out of pocket. This means that figure is subtracted from the cash you are required to pay to close your mortgage. This could also explain the difference between the closing costs you are required to pay and the figure listed on your Loan Estimate.
Another possible reason why the closing costs figure on your Loan Estimate is higher than your actual costs is because your lender "padded" the estimated closing costs on the Loan Estimate. In some cases lenders use conservative estimates of closing cost items such as the appraisal report, recording fees and other expenses.
Lenders build a cushion into the costs on the Loan Estimate to account for unexpected fees that may arise over the course of the mortgage process. Additionally, according to mortgage regulations, certain closing costs such as lender fees cannot increase while other costs such as title insurance and settlement agent fees can only increase by 10%, as compared to the original cost figures outlined on your Loan Estimate.
You can determine how much your closing costs changed by comparing the Loan Estimate to the Closing Disclosure document that lenders are required to provide at least three business prior to your mortgage closing. The Closing Disclosure outlines your final, actual mortgage terms.
Review How to Compare the Closing Disclosure to the Loan Estimate
Because there is a limit on how much certain closing costs can increase, lenders may use more conservative cost estimates to make sure they follow mortgage industry guidelines. The rationale is that overestimating closing costs results in you paying less than expected, which generally a good outcome.
On the other hand, underestimating costs can create a significant issue for both you and the lender, especially if you lack the funds to pay the higher costs. In a worst case scenario, if your actual closing costs exceed the costs listed on your Loan Estimate your mortgage closing may be delayed.
So although it is best for lenders to be as accurate as possible when they estimate your closing costs, most borrowers prefer that their lender is conservative rather than aggressive because your actual costs end up being lower than expected, which is usually better from a financial standpoint.
The final reason why your closing costs may be different than the costs on your Loan Estimate is because some lenders use an earlier estimated mortgage closing date which increases your estimated prepaid interest and potentially your property tax, homeowners insurance and monthly mortgage insurance costs.
When your mortgage closes, you are required to pay interest from the closing date until the end of the month in which your loan closes. If your mortgage closes later in the month than the date assumed by the lender on your Loan Estimate, then your actual prepaid interest cost is lower than the figure on the Loan Estimate. Because the amount of prepaid interest you pay is not determined until your mortgage closes, using an earlier closing date means that the lender is being conservative.
In closing, there are many reasons why your actual mortgage closing costs may be lower than the costs disclosed on your Loan Estimate. Paying lower closing costs is usually a positive development but you should ask your lender for an explanation if you have questions or concerns.
Loan Estimate: https://www.consumerfinance.gov/ask-cfpb/what-is-a-loan-estimate-en-1995/
Closing Disclosure: https://www.consumerfinance.gov/ask-cfpb/what-is-a-closing-disclosure-en-1983/