Updated Forms Will Give Buyers Much-Needed Information

By Benny L. Kass
Saturday, November 22, 2008

Two of the most important documents for home buyers are getting a long-awaited overhaul.

Earlier this month, the Department of Housing and Urban Development unveiled revised versions of these forms, the good-faith estimate (GFE) and the settlement statement (HUD-1). The agency first proposed changing these forms several years ago, but there has been industry resistance. Lenders must use these versions starting Jan. 1, 2010.

The GFE and HUD-1 aren't new. Lenders already use versions for any mortgage involving one- to four-family residential properties. But there have long been complaints that the current versions of the forms can confuse or mislead borrowers, instead of enlighten them.

The forms are among the most visible requirements of the law that covers home-sale closings, the Real Estate Settlement Procedures Act. The stated purpose of RESPA, enacted in 1974, was to help consumers become better shoppers for settlement services and to eliminate kickbacks and referral fees that increased the cost of closing on a home.

These objectives have not been realized. "The mortgage crisis was fueled in part by people agreeing to mortgages that they ultimately could not afford," HUD Secretary Steve Preston said when announcing the revised forms. "In some cases, people didn't understand or know that their mortgages could result in large payment increases after just two or three years."

The law requires that the lender give a borrower a GFE within three business days of the loan application. That estimate covers projected settlement and closing costs. Unfortunately, as many borrowers have learned the hard way when they sat down at the settlement table, this information is only an estimate, not a commitment. All too often, borrowers are shocked at the extra undisclosed costs.

The HUD-1 must be given to the home buyer at settlement. Among the host of documents that must be signed at the closing, it is perhaps the most important. It lists the costs of the entire transaction.

The new versions of the forms highlight some charges that were far from obvious on the older versions. Among them are the fees lenders pay to brokers to obtain loans, known as yield spread premiums. These often result in higher interest rates for borrowers. Preston said: "HUD will require that the compensation lenders pay to mortgage brokers be more fully disclosed. These so-called yield spread premiums are rarely understood by, or fully disclosed to, borrowers. Consumers deserve to understand this, and they need to get credit for essentially paying these premiums."

What does this mean for the borrower? Armed with information as to how much money the mortgage broker may be receiving from the lender, a customer will have the opportunity to negotiate a better rate. A basic principle in mortgage lending is that one can buy down interest rates by paying points. Typically, one point (i.e., 1 percent of the loan amount) can reduce the rate by about one-eighth of a percent.

The new good-faith-estimate form is three pages long. It is designed to provide basic information -- in simple English -- so that would-be home buyers will have answers to questions such as:

· What is the term of the loan?

· Is the interest rate fixed, or can it change? If the rate is adjustable, when will the change take place? What is the maximum monthly payment?

· Is this a balloon note? That means that even though you pay the lender each month, it's not enough to completely pay down the loan, so at the end of a set period, the balance becomes become due; that is, it balloons.

· If the mortgage is refinanced, will there be a prepayment penalty? If so, how much?

· How much money will be due at settlement for closing costs?

All this information is meaningless, however, if the dollar amounts change at the settlement table. It's usually too late to complain. The seller expects the buyer to go through with the purchase as agreed in the sales contract. A buyer who tries to back out because loan charges change could be in default on the contract. The seller could try to keep the earnest-money deposit and sell the property to someone else. As far as the seller is concerned, dealings between a buyer and lender are irrelevant.

The new form adds an explanation of which charges can change at settlement, which can't and which can vary by no more than 10 percent.

The revised GFE and HUD-1 are meant to work together to help the borrower verify these charges. The third page of the settlement statement breaks charges into those same three categories and refers to them by the line number on the estimate form. "Borrowers will now be able to easily compare their estimated and actual costs," said Brian Montgomery, commissioner of the Federal Housing Administration.

Perhaps the most significant change in the new HUD-1 is a section titled "Loan Terms." This will contain almost the same information about things such as loan size, rate and other terms that was in the good-faith estimate. It will make it very easy for the consumer to confirm at settlement that the lender is honoring its promises.

These two documents are important steps toward the goal of allowing borrowers to fully understand upfront what it will cost them to buy their house. "None of us can lose sight of the fact," Montgomery said, "that millions of Americans simply don't understand all of the fine print of their mortgages, and this, in many respects, is at the heart of today's mortgage crisis."

I hope that legitimate mortgage lenders will not wait until Jan. 1, 2010, to adopt these consumer-friendly changes. They should begin using the forms as soon as their computer systems make them available.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.