The cost and confusion of real estate settlements

For most families, the purchase of a home represents the single largest financial obligation of a lifetime. It’s all part of the “American Dream” according to the pitchmen for builders, lenders, brokers and other assorted players who make up the lucrative real estate industry. Too often, the “dream” becomes something closer to a nightmare when the homebuyer-already facing the daunting prospect of long-term mortgage payments and moving costs-reaches the moment for signing the final papers only to learn then that it’s not just those huge principal and interest outlays, but an array of fees called “settlement costs” that must be paid before the front-door key is handed over.

Here’s the way Mel Martinez, Secretary of the Department of Housing and Urban Development, described the problem recently in testimony before the Financial Services Committee of the U. S. House of Representatives: After agreeing to the price of a house, too many families sit down at the settlement table and discover unexpected fees that can add hundreds if not thousands of dollars to the cost of their loan. And at that point, they have no viable options. On the spot, the borrower is forced to make an impossible choice: either hand over the extra cash and sign or lose the house.

This is no nickel and dime problem. Americans spend an estimated $50 billion dollars each year in real estate settlement costs. It is a dizzying list of charges added for such things as loan originations, appraisals, credit reports, various inspections, mortgage insurance applications, mortgage insurance premiums, hazard insurance premiums, flood insurance, title fees, title examination, title insurance, document preparation, attorney’s fees,lender’s title insurance, recording and transfer fees, surveys, courier fees for the delivery of documents…the list goes on and on.

The cost and confusion of real estate settlements has long plagued homebuyers. In an effort to provide more timely disclosures and other reforms, Congress adopted t he Real Estate Settlement Procedures Act (RESPA) in 1974. But there have been dramatic changes in the housing industry and in lending practices. The need to update the 28-year old law has long been obvious.

Secretary Martinez has proposed new regulations which he contends can simplify the settlement process and save homebuyers as much as eight billion dollars annually-an average of $700 per closing. The regulation, among other things, is designed to significantly improve the “good faith” estimate of settlement costs provided to homebuyers prior to settlement and would allow lenders to offer guaranteed mortgage packages covering interest rates and lender-required settlement costs. Under the guaranteed package approach, settlement costs cannot vary from the time the offer is made. The interest rate guaranteed in the package can vary only on the basis of an observable index or yardstick. The package, which must remain open for 30 days, would be simplified to provide easy cost comparison with competing offers.

The public comment period on the rule ended in October and a final version of the regulation will be published early this spring.

It may take legislation to save another of Secretary Martinez’s initiatives on RESPA. The 8th Circuit Court of Appeals ruled against HUD’s attempt last month to use RESPA to ban markups (padding) of some closing cost fees-the so-called “junk fees.” The court ruled that while HUD had authority to ban kickbacks and fee splitting under RESPA, the law did not give the department the right to ban surcharges-even unconscionablemarkups– that some firms were placing on closing costs. Ken Harney, who does a remarkably thorough job of tracking housing developments around the nation, predicts in his latest nationally syndicated column that Congress will be asked by HUD for explicit authority over such markups when it reviews Secretary Martinez’s broader reform of RESPA later this year.

Unless Congress does act, Harney noted that lenders, title companies, mortgage brokers and other settlement-service providers will be left free to continue practices like charging $65 for a credit check that actually costs $9 or charge $350 for “full appraisal” which, in reality, was performed electronically and cost the lender only $50 or allowing a $55 courier fee for delivery services that only cost $15.

While HUD’s proposed reforms for RESPA need some fine tuning and clarification in some areas before the final version is published, it is becoming increasingly clear that Secretary Martinez is very serious about ending the gouging of homebuyers at the settlement table. His public statements make it clear that not only does he feel this a “fairness” issue for consumers, but also a fundamental need if we are to increase homeownership, particularly for low and moderate income citizens.

“The mortgage finance process and the costs of closing are major impediments to homeownership,” he says emphatically. And he ties that statement directly to the Bush Administration’s announced goal of creating 5.5 million new minority homeowners by the end of the decade.

It will be interesting to see how a Republican-led House and Senate will respond to Republican Secretary Martinez’s initiatives to end the long-standing and gigantic ripoffs of homebuyers.