A Study of Closing Costs for FHA Mortgages

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Abstract

This report analyzes FHA borrower closing costs using data from 7,600 FHA-insured, 30-year fixed-rate home purchase loans. Total closing costs paid to mortgage originators are substantial, averaging just under $3,400. Borrowers in neighborhoods with more minorities and lower educational attainment consistently pay higher costs than others. Loans with simpler terms are less expensive. Borrowers who use "no-cost" loans and so can shop on interest rate alone pay $1,200 less than borrowers who pay some lender or broker fees in cash. This suggests that consumers have a tougher time comparing alternatives when trade-offs are involved and that mortgage loan markets are not fully transparent or competitive.

Introduction

This study analyzes the closing costs and mortgage terms for a nationwide sample of 7,560 FHAinsured, 30-year fixed-rate loans made for the purchase of a house. The study is motivated by several considerations. One is to evaluate the success of the Real Estate Settlement Procedures Act of 1975 (RESPA) and its implementing regulations. The original goal of RESPA was to assure competition in the mortgage market and to make it easier for borrowers to shop for mortgage loans by mandating good disclosures. HUD writes the regulations for and enforces RESPA but has, until this study, lacked any data for studying RESPA’s effectiveness.

A second goal is to study the role of mortgage brokers. As mortgage brokers became an important part of mortgage lending through the 1990s, their compensation became controversial. Brokers may be paid both by borrowers (in up-front cash fees) and by wholesale lenders (in cash payments called yield-spread premiums [YSPs], which depend on the interest rate on the loan). Plaintiffs in litigation charged that YSPs were illegal kickbacks under RESPA. This litigation produced detailed data on closing costs and mortgage terms that had not been studied before, mainly because of the high cost of retrieving and assembling such data. Analysis of the data turned up evidence of wide variations in terms received by borrowers, differential charges by race, even larger differentials by borrower education, and suggestive evidence that simpler loans facilitated more effective mortgage shopping, resulting in better terms for borrowers. These findings question the effectiveness of present mortgage disclosures. One issue on which the litigation did not shed much light is whether borrowers get different terms from brokers versus direct lenders. That issue is addressed in this study.

In addition, there is increasing awareness that many consumers struggle to understand all financial products, not just mortgages, especially those with numerous and complex terms. A growing academic literature focuses on these issues. Federal agencies responsible for disclosure rules and regulations have done little to assess whether consumers understand required disclosures or whether improved disclosures could contribute more to consumers’ understanding. This is changing; new research on disclosures is under way, and the potential for disclosures to help financial consumers is coming to be appreciated. One goal of this study is to seek evidence on whether mortgage borrowers might benefit from improved disclosure.

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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