June 19, 2003 | WebMemo on Regulation
With mortgage rates at all-time lows, millions of Americans are purchasing or refinancing homes this summer. For the vast majority, financing a home will be the largest-and most complex-single financial transaction they will ever make.
Unfortunately, the cost is made larger by federal regulation. Congress and the Administration now have the opportunity to make federal regulatory changes that can yield considerable savings.
An upscale car may cost $40,000 or more, but the median priced new home in America is now running at about $185,000, more than four times the median annual income of American households. But the high sales price is only one of a number of factors that make a home purchase uniquely different from anything else we buy. Other important differences are the sheer complexity of the process and the substantial cost associated with the dozens of fees, charges, and other transactions costs incurred in the process.
Defenders of the current process argue that the complexity-and the extra costs and fees-are justified and that they stem from the fact that a home purchase is really a "dual" purchase. Not only is the buyer acquiring a home but, because the typical home is so costly compared to the buyer's income, homebuyers are usually also acquiring a 30-year loan obligation, and many of these costs and associated red tape relate to the loan. While this is certainly true, it is also true that most automobile purchases are, likewise, financed. Yet, the cost and complexity of buying and financing a car are trivial compared to those involved with buying a home.
The cost and complexity of the typical home purchase can be illustrated by using numbers from an actual real estate transaction, the purchase now under way of a home in South Carolina. As Real Estate Settlement Procedures Act (RESPA) currently requires, prospective lenders for a home purchase are required to provide the prospective buyer/borrower with a Good Faith Estimate (GFE) of how much the process will cost over and above the price of the home.
In the South Carolina transaction, the purchase of a $150,000 home is being financed with a 90 percent loan ($135,000) and is projected to entail additional fees, charges, pre-paid items, taxes, and costs totaling $5,900 according to the lender-provided GFE. This $5,900 comprises15 separate charges, ranging from a "wire" fee of $15 to a loan origination fee of $1,350. Moreover, because this is only a "good faith" estimate, these costs and fees can change by the time settlement occurs.
These extra expenses, of course, have to come out of the buyer's pocket at closing and, in this case, that means that the buyer must have a total of $20,000 in cash to buy the house-$15,000 for the 10 percent down-payment and $5,900 for closing costs.
Given the difficulty that young, modest-income, entry-level buyers have in coming up with the funds for the down-payment alone, the extra $5,900 can be a significant obstacle to homeownership for some families.
Although consumers have a statutory right to be informed of these costs through the Good Faith Estimate required under the RESPA, this legislation may itself be responsible for making many of these costs higher than they need be. The law bars lenders-or others-from "bundling" (offering as a package) lending services along with other services such as title insurance and lawyers' fees.
Although the intent of this restriction was to further consumer choice and enable consumers to choose their own lawyers and title companies, in practice, it has made things worse for consumers. Not only are lenders unable to guarantee an exact total closing cost, but they are also unable to negotiate with these other vendors to obtain lower prices for third-party services. The perverse result is that a law intended to help consumers is actually making them pay more.
In response to these unintended cost consequences, in July 2002, the U.S. Department of Housing and Urban Development (HUD) proposed significant changes in the rules governing real estate settlement costs that would provide buyers with new cost-saving settlement options.
Under HUD's proposal, lenders and others would be allowed to package services so that they could offer buyers a single, all-inclusive price. At the same time, they would be required to provide borrowers with either an Enhanced Good Faith Estimate or a Guaranteed Mortgage Package (GMP), presenting them with a single price for all settlement costs and services.
$1,000 Savings Per Borrower
Many view the proposed Guaranteed Mortgage Package as the most far-reaching of the two options. According to HUD studies, the GMP could potentially result in aggregate real estate settlement cost savings of an estimated $10.3 billion per year. At the current pace of about 10 million real estate settlements a year (including refinancing), this total savings translates to approximately $1,000 per borrower. This is not a bad result for a regulatory change, and it would certainly be welcomed by the moderate-income, entry-level buyers who can sometimes find costly up-front charges, combined with their down-payment, a deterrent to ownership.
Buyers who prefer not to pay their settlement service fees in a lump sum could, instead, use HUD's proposed Enhanced Good Faith Estimate. Under this plan, various fees and charges would still be itemized for the buyer, as they are under the current GFE process. Although the total cost would not be guaranteed, some of the lender-related charges would have be firm quotes and final third-party charges could not vary more that 10 percent from estimate. (Under existing law, there are no limits imposed on the extent to which total estimated GFE costs could change within the period from the day that the estimate was provided to the actual settlement date).
As Congress sorts through these various contentions and concerns of this issue, it is essential that they keep in mind the huge financial benefits that the proposed RESPA reform would likely provide to homebuyers. There are few federal regulatory changes that can yield savings of this magnitude, and Congress and the Administration ought not to allow the opportunity to slip away.