Buying a house is a major undertaking, one that usually requires borrowing tens or even hundreds of thousands of dollars. As part of the home-buying process, consumers typically bear significant and often unexpected closing costs. To help consumers shop for a mortgage and avoid unexpected closing costs, the new Bureau of Consumer Financial Protection is proposing “Know before You Owe” mortgage disclosure forms.
Two elements of home-buying closing costs are title insurance and other related settlement costs. Naturally, lenders want to make sure the owner has full title to the property so that the home is genuine collateral for the mortgage. The lender’s confidence that the loan will be repaid by the owner or by selling the property is critical in keeping borrowing rates low. In a competitive market, the price of the insurance and settlement charges would be determined by costs plus a modest profit. But some worry that regulations and anti-competitive practices push up prices, raising the overall costs of buying a home and potentially reducing homeownership. Moreover, many of these costs are borne with every mortgage refinancing.
A new Urban Institute report for the U.S. Department of Housing and Urban Development reveals a pattern of title charges that is hard to explain by costs alone. Median title charges vary widely from $1,867 in Broward County, Florida, to $914 in Philadelphia County, among the five metropolitan areas in the study. Even within a metropolitan area, the Urban Institute report finds that shopping for title insurance across settlement agents would save several hundred dollars. The data for the analysis comes from records of 3,000 FHA-insured, 30-year fixed-rate home purchase loans from 2001.
For clues about anomalies, let’s first look at the likely determinants of title charges and how they vary with home prices. The first cost involves abstracting, examining, and documenting who owns the property and finding out about past or current challenges to ownership. This cost should vary little with home prices, but should vary by the level of effort in title search, potentially related to the home’s turnover. A second cost is the time preparing papers and conducting the settlement. A third component is the title insurance premium, a cost likely to vary with the price of the home because high-value properties, other things being equal, should be more expensive to insure.
The report reveals widely varying determinants of title charges across five metropolitan areas. In several cities, title charges make up a high proportion of home prices, especially for low-priced homes. At a home price of $60,000—about the 16th percentile of U.S. home values in 2001—homebuyers in Cook County (Chicago), Illinois, had to pay an average of $1,569 in title charges, about 2.6 percent of the home value. By comparison, title charges were 50 percent lower in Philadelphia, or an average of $902. One reason the Chicago charges were so high is the prevalent practice that buyers use a lawyer.
Given the high fixed component of settlement costs, title charges start high but drop in percentage terms as home prices increase. In addition, the gap between localities narrows considerably. At a home price of $200,000, the settlement charge burdens ranged from 0.9 percent to 1.1 percent across the five metropolitan areas.
The report’s evidence shows that closing costs are most burdensome for low-priced homes. Moreover, these charges are only part of the transaction costs of obtaining or refinancing a mortgage, including application and appraisal costs. Finding ways to limit overall transaction costs of refinancing, perhaps through an automatic refinancing mechanism, would help all homeowners, especially those in low-priced properties.