Closing costs are hard enough to understand without lenders adding to the confusion. There are many different terms thrown about, and I find daily that clients are confused by disclosures and terms that sound similar but have different meanings. Here comes help...
First off, two super-useful, old-school terms that will be most helpful:
Closing costs: These are the one-time, transactional costs or fees associated with getting the loan. It should be all inclusive, and may or may not include “discount points” or “points”, which are related to the interest rate. In many cases, your costs and points are not dictated, but a matter of your choice.
Prepaid expenses: These “prepaids” are prorated/recurring charges that are NOT a cost of getting the loan, but ongoing expenses. Primarily property taxes, homeowners’ insurance premium and/or dues, and some prorated daily interest for the odd days at the month-end when you close.
Plus a few new ones added by recent regulation, just to add to the excitement:
NOTE: Added or highlighted in 2010, when HUD (the Department of Housing and Urban Development) changed the old one-page Good Faith Estimate into a new unrecognizable 3 page document, and added new terms. You may or may not find them useful.
Total Settlement Charges: total of all closing costs and prepaid expenses
Origination Charge: subtotal of only the fees that the lender receives, without other third party fees/costs or prepaids
Adjusted Origination Charges: subtotal of “Origination Charge, plus or minus “Points” (see below). It is much clearer to look at “Closing Costs”, since that’s more inclusive.
And a few more to be super clear:
Interest rate: the rate at which interest accrues day by day on your loan…the true rate.
APR: “Annual Percentage Rate”, a less useful figure, promoted as a shopping tool for consumers, but one that has major problems. Attempts to show the total annualized rate (cost as a percentage) of borrowing. Like: “if you do exactly such and such, and finish in so many years, the annual cost was X.” Not the same as interest rate.
Points or “Discount Points”: One "point" = 1% of the loan amount. Either positive or negative…a fee you either pay or finance at closing for a lower rate, “positive points”; or what I call “negative points”, a lender credit to reduce your closing costs. Either one is possible with most loans, and it’s partly a matter of your choice.
“Prepaid Finance Charge”: A subtotal of only SOME of the closing costs specified by the law to calculate APR.
“Amount Financed”: This is the loan amount LESS the prepaid finance charge, used only to calculate APR.
P&I: “Principal and Interest” payment. This is the monthly payment for just the mortgage, without taxes, insurance, etc. This is what pays the interest as it accrues, plus a portion to reduce loan balance over time.
PITI: “Principal, Interest, Taxes and Insurance” payment. This is the total payment (sometimes shown to include homeowner’s dues, and mortgage insurance if applicable). Used by underwriters in qualifying you. You’ll see this on many disclosures whether you pay your taxes and insurance in the monthly payment or not.
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