How to Read a Good Faith Estimate or HUD-1

It can be difficult to compare apples-to-apples when looking at closing cost estimates from lenders. There are lots of tricks that a lender can pull to make themselves look better, and there are so many expenses that’s it’s difficult to know which ones are “junk fees.”

Let’s review terminology first. When you make a loan application, a lender is required to provide you with a Good Faith Estimate (GFE). Most lenders provide you with this estimate even if you haven’t made a full application yet. The GFE contains three main parts: your rate/point combination, your monthly housing payment estimate, and an estimate of your closing costs. Though lenders are required to give you an estimate of closing costs—which run 2.5% to 3% in this area—they actually have no control over most of the fees shown! So be warned: do NOT compare lenders based on total closing costs! There are too many places they can under-estimate to make themselves appear more competitive.

The GFE closing cost estimate is an estimate of what will ultimately be shown on the HUD-1 at closing. The HUD-1 is a standard government form with each line item numbered for easy comparison. GFEs, on the other hand, come in a variety of format, further complicating comparisons.

Generally the expenses on GFEs and HUD-1s will fall into these categories:

Total Sales/Broker’s Commission	Section 700 on the HUD-1, and usually not shown on the GFE because this section is an expense of the seller.
Items Payable in Connection With the Loan aka “Lender’s Fees”	Section 800 on the HUD-1. These are your lender fees, and the most important part of your GFE because this is the part your lender actually controls, and is, at least in part, negotiable. This section will also include any points that you are being charged to get your loan rate. So you must compare this section in conjunction with comparing the interest rate charged.
Items Required by Lender to Be Paid in Advance	Section 900 on the HUD-1. This section is primarily driven by the day of the month you close. Lenders require that you ‘pre-pay’ the interest between settlement day and the end of the month. So if you close on the 1st, you owe 30 days of interest. If you close on the 30th, then you owe one day. If you’re comparing lenders, make sure they all use the same assumption for purposes of the GFE. As long as you’re comparing apples to apples in rates and points across lenders, you can ignore this section.
Reserves Deposited by Lender aka “Total Prepaids/Reserves”	Section 1000 on the HUD-1. Most lenders are the same in what they require—a year of hazard insurance, a few months of property and other local taxes, mortgage insurance, and possibly a month of condo fees. The lender doesn’t actually control this section of the estimate, so it’s safe to ignore it in your ‘shopping’ of loans.
Title/Settlement Charges	Section 1100 on the HUD-1. The settlement company determines this section, so it’s safe to ignore it in your comparison of lenders. This is a big chunk of your fees because it includes title insurance.
Government Charges	Section 1200 on the HUD-1. The local jurisdiction determines this section, so it’s safe to ignore it in your comparison of lenders.
Miscellaneous	Section 1300 on the HUD-1. Contrary to popular belief, this is not where the “junk fees” are. Instead it tends to be actual costs incurred for couriers, the survey of the property, and other fees that don’t fit into one of the above categories.

Read more: "Junk Fees"

Read more: Title Insurance

Foreclosure Risks: Unpredictable Transaction Timing--Don't Pack Those Boxes Yet!

I’m often asked about the risks involved with buying a foreclosure. This is the second post in a series of as-yet-undetermined size. (Have a question on the risks? Contact me.) The first post on REO Bank Addendums covered the all encompassing risk—the risk that the bank can basically do whatever they want, including walking away at any time with no penalty, if you’re not very careful with what you sign. That addendum always includes one or more clauses protecting the bank if they are unable to meet certain deadlines—like actually proving they are the owner (oh, do I have to OWN the property before I sell it?) before settlement. These broad clauses lead to our second major category of risk: controlling the timing of the transaction.

In a typical transaction, you make an offer, the seller takes a day or so to review it and either a) accept, b) counter, or c) reject. If you’re concerned that a seller might be “sitting on the offer” to wait for a better one, or even “shopping it around” by calling all the agents who have previously visited the property to see if they can scrounge up a competing offer, then you might consider including an expiration or exploding clause. These clauses state that the offer will expire by x time and date if not responded to in writing. It’s a great way to protect a buyer and maximize your chances of a quick turnaround.

However, with a bank owned property, the bank takes as long as they darn well please. Might be a day, might be a month, might be several months. They don’t really care about your expiration clause. Well, maybe not that they don’t care, it’s just that they’re a big corporate entity, and your offer is likely to be sitting in a pile of paperwork that needs to get done asap, but the individual sitting in a cube somewhere really doesn’t have the right incentives to make sure he gets to your offer today, or tomorrow, or the next day.

In the meantime, you’d be wise to keep looking at properties to see if there’s anything better that catches your eye. As a buyer you have the right to withdraw your offer anytime before the bank gets back to you. In reality, the bank’s response will NEVER be an “accept.” Rather, it will ALWAYS include that pesky Bank Addendum that you will have to read (please, I beg of you, read) and sign before your contract becomes official.

Once you’re ratified, is it time to give notice on your lease and call the movers? Hardly. Remember one of the common clauses is for the bank to give themselves the right to back out at any time. I’m not saying the bank does this out of malice…there are a million reasons (deed issues or delays are common) the bank might be very willing, but simply unable, to proceed to settlement. (You’d be out the cost of your appraisals, inspections, moving deposits, etc in this case.) As an aside, you can be sure that one of the clauses in that Addendum imposes a hefty daily financial penalty on the buyers if they aren’t ready for settlement on time, so apparently what’s good for the goose is NOT good for the gander.

Other than not being sure when to start packing, this open-ended timing creates issues with financing. Most loans are locked for just 30 days, and after that you need to pay a fee to maintain the lock. If you pay the fee, you may be out that money and never close. If you don’t pay it, and rates change, you may be in an even worse situation—in fact you may not even qualify for the loan anymore if rates change too much! Make sure you fight hard for a financing contingency that will protect you in the even that settlement gets delayed. (Side note—often banks will offer to give you financing in the event of problems…but they never specify the terms!)

So when can you start making plans? Not until the deed has been recorded, which is typically the day after settlement. Yes, you read that right. Don’t make any plans to move until a day AFTER SETTLEMENT OCCURS.

If your lease is up soon without the option to go month-to-month, make sure you have a back up plan for where to stay in the event of unforeseen delays. The timing risk can be partially mitigated by 1) continuing your search knowing you have the option to walk away and 2) keeping a financing contingency. But chances are strong that you’d incur extra expenses, along with sleepless nights, along the way.

Thinking of buying a foreclosure? Contact me to discuss the other risks and how you might be able to mitigate some of them. Remember, it's not a bargain if you're taking on too much risk for not enough reward.

Read the next post in the series on Foreclosure Risks: Property Condition & Inspections

Read more on the differences between short sales, foreclosures, and REO properties.

Read the first post in the series--risks related to Bank Addenda--here.

Foreclosure Risks: Read Those Bank Addenda!

I get a lot of questions on foreclosures. How could I not? Some neighborhoods are flooded with them (though some are not...see the graph in my post on Beyond Auctions.) Buyers want to know if they’re a good deal, what the risks are, and how they can get in on one.

I’ve decided to write a series of posts on the risks specific to buying foreclosures—trust me that there are too many risks to put into one post! Some risks can be mitigated, some can be eliminated, but most remain; that’s part of the trade off you make in deciding to buy a foreclosed property.

First, a quick overview on the process. (For a review of how a home moves from short sale to auction to REO, read the post “I want to buy a foreclosure.”) Once a home is foreclosed upon, also known as Real Estate Owned or bank-owned, it is usually listed in the MLS with a listing agent, similar to any other home for sale. It will usually be noted right in the comments that this is a “bank owned property” or “special addenda required.” What is this special addenda?

When you decide to make an offer on a foreclosure, you put together the offer using the standard regional forms, just like any other resale (though not the same as new construction—for those you use the builder’s contract.) You include any contingencies or other negotiables you want—home inspection, seller subsidies, etc. Then you send it off to the listing agent, who sends it to the bank. The bank’s representative may respond right away, they may throw it into a pile to see what else comes in, or they may not do anything. (So controlling the timing becomes a big risk of a foreclosure, but I digress.) Let’s say they get back to you and let’s assume they even agree to all of your terms. They’ll return it all with a copy of their own Bank Addendum. An addendum is simply the legal term for a condition that amends the main contract. Even “regular” resales have a half dozen addenda-- for home inspections, appraisals, and to meet jurisdictional requirements. Bank Addenda are written by the bank’s lawyers to protect themselves during foreclosure transactions. Any guesses on which side they favor?

Every bank’s addendum is different, and it’s critical that you read and understand every clause prior to signing it. Because it’s an addendum, which amends the main contract, it doesn’t really matter what you think you negotiated—anything in the addenda trumps the main contract. Think you negotiated an inspection but the addendum says no? Or what if the addendum says you can inspect but not void? The addendum wins the day. A lot of good that inspection does you if the home inspector says the place needs to be demolished by you aren't allowed to walk away.

Unless you sign the addendum, there’s no deal, so you can still get out if you don’t like what you read. Occasionally, on some clauses, you may be able to negotiate certain clauses, but that increases the likelihood of slowing down the process—after all, some guy in a cube in Idaho (no offense, readers in Idaho) has to get that change sent to the bank’s lawyers to review, and I guarantee that those lawyers have their hands full with all their other foreclosures right now. If you decide to live with the clauses, then once you sign the addendum, the contract proceeds as is more typical.

There are many examples of egregious clauses, but here are a few of my favorites:

- The bank may not own the property and may not be able to go to settlement. You may be required to go to settlement even if the bank cannot deliver the deed at that time.

- The bank may guarantee only insurable title, not marketable title (more on that in another post)

- The bank may give themselves the right to change their mind and walk away at any time up to settlement for no penalty

- There may be easements or restrictions on the property that aren’t recorded; if you find one, the addenda may prevent you from backing out of the contract as a result

There are many more, as these addendum often run about ten pages. Because they are written to apply nationwide, there are occasionally even clauses that are illegal in Virginia!

So read those addenda carefully, and caveat emptor on this foreclosure pitfall. It’s a doozie.

I’ll continue the series with future posts on these other critical risks:

- Lack of control over turnaround and the dependent risks it creates for buyers (and not just your move date)

- Inspections, repairs, and warranties

- Financing complications (Don’t rely on using an FHA loan!)

- Title and deed issues

- Condo/HOA docs

Have another risk you want addressed? Add it in the comments and I’ll write about it.

Are you thinking about buying a foreclosure and want to know the risks you’ll face? Contact me to discuss the risks and some mitigation strategies.

Read the second post in the series, about the challenges in controlling the timing of a foreclosure transaction, here.

Two Buyer's Agents You Should Never Use

One of the projects I'm working on is an article about agents you should never use. No, I'm not naming names, but rather categories of people that you should think twice about hiring if you're buying a home. Two of them were mentioned during a "Chat Plus" column in the Washington Post (read it here.)

The first category of "agent" you shouldn't use--though it's perfectly legal if the right disclosure forms are signed, and no doubt many agents would argue with me on this one--is the listing (or seller's) agent. This is the agent that has been hired by the seller to get the best deal for them. They have a legal and moral responsibility to keep information confidential, and to look out for the seller's best interests. In DC and VA, it's legal for an agent to be a "dual agent", meaning they can represent both sides. I wish someone could tell me how it's possible to have both people's interests at the top of their mind when negotiating a deal. My clients look to me for advice, and in a world of negotiation, it's quite frequently the case that what's best for one side is not what's best for the other. Yes, I've read the "win-win" books, and "getting to yes" strategies, but seriously, in today's real estate market, isn't 90% (or more in many cases) of the deal price? Maybe not for the agents out there, but I have yet to come across a buyer or seller who, if forced to rank what's important, doesn't say "price". And if I'm fairly representing both sides, isn't every dollar I negotiate hurting at least one of my clients?

Now the argument I hear from buyers is "I'll save x% if I don't have an agent." And that's a big myth. The truth is that the commission is negotiated between the seller and the listing agent before the property ever even goes into the MLS. That (full) commission is getting paid even if you don't have buyer representation. The only way around that is if the buyer negotiates with both the seller for the property, and the seller's agent (for the commission). So that agent is taking on more risk (because you're not represented), more work (because chances are you don't know the paperwork that's required and how to interpret it), for less pay. Not impossible, but I know a lot of agents who wouldn't do it. And of course if there's another potential buyer who DOES have representation, isn't it fair to argue to a seller that the buyer in that case is less risky? There's less risk of something falling through the cracks and blowing up at the last minute because there isn't someone guiding that buyer through the process.

The other issue is that the x% is already "priced in" to the list price. The seller knows that, the agents know that, and the buyer knows that. So if a buyer comes in and says "I don't have an agent, so I want x% off," don't you think the seller wants that same x% back?

Of course these are all generalities, and there are exceptions to the rule, etc., etc. My point is simply that it's not as straightforward as saying "I'll just negotiate the x%."

This is a complicated issue, and one that people get passionate about. (Don't they always when money is involved?) There are lots of qualitative reasons buyers should use an agent too, but I'll save those for another post.

By the way...I mentioned that the WP chat discussed two agents you should never use. The second? Yourself, to avoid the very issue discussed in the chat--signing documents you don't understand.