How a Loan Estimate works

Certified Mortgage Advisor
NMLS 1701021
Published 
September 29, 2021

How a Loan Estimate works

One of the most terrifying things about getting a home and getting a mortgage is what are all the details? How much do I have to pay per month? What's my interest rate? How much interest am I going to pay over this loan? What are the total costs? What are the hidden fees that might come up? When you're under contract for a home, you're going to get a document. In fact, every single loan officer is legally required to send you a specific document called a Loan Estimate within three days of being under contract.

So it's really important that you understand all the nuances of this document. So you can have a lot more clarity about what's going on. So we're going to break down the entire loan estimate. Everything that's going on in there so that you can have a better understanding of what your rate and payment is, and how much everything's going to cost. So you can feel like you're more in control of the process and have a handle on what's going on. Instead of feeling like you're going into this a little bit blind. And even though this is a document that's required to be sent to you, there are a lot of people who gloss over it and they don't actually know how to read it because it can be a little bit confusing.

What is Loan Estimate?

So a little bit of a background of what the loan estimate is. It's three pages, and it's going to detail mainly the terms of your loan and the costs of your loan. The goal for it or the reason the government put this into place, is it is supposed to be a good faith estimate. So the lenders' best idea of how much this loan is going to cost.

Loan Estimate is like a guide

So think of this, like a map of your loan, there are some things that the lender can tell you that is exactly true about your loan. For instance, the interest rate, the mortgage insurance you're going to pay, and how much the lender charges. However, there are also a lot of other things that the lender has to estimate.

Why do we need to know the details?

That's why this is called a loan estimate, it's a map. It tells us most of the details, but it's still the lender's best estimate about a purchase transaction. And the reason why it's an estimate is there are things that are actually in your control, things like homeowners, insurance how much the title company costs, depending on who you shop with for title insurance. So all these things can change and that's why this is an estimate here.

Required in receiving loan estimate

So let's first talk about what is required in receiving a loan estimate. So there are rules, basically, six rules that trigger a need for a loan. If a lender receives your name, your income, your social security number, a property address, an estimated value of the property, and the mortgage loan amount sought, and how much loan do you want to get.

When will you receive a Loan Estimate

Then a lender is legally required to give you a loan estimate within three business days. This isn't an option, this isn't something that a lender will not give you if they didn't really feel like it. It's a legal requirement that they have to give you.

Closing Disclosure

A closing disclosure is similar, but there are multiple different types of estimates you're going to be getting through your home purchase. So let's talk about this first section and we'll cover this a little bit more in detail. Don't forget to save this loan estimate to compare it with your closing disclosure.

Why get different loan estimates?

We might actually get multiple different loan estimates as things change. For instance, if your interest rate becomes locked instead of floating, you might get an updated loan estimate. So you could get several different loan estimates, but we're just going to talk about the initial loan estimate. Following up loan estimates would be if anything changes during the process that would be called a change of circumstance. And we'll talk a little bit more about that later. But the loan estimate here, the closing disclosure is when we get closer to closing you're going to get a document that likely still is an estimate, but it should be a much, much closer estimate. Likely you'll get one closing disclosure in the beginning. That's much closer to your final fees than the loan estimate and then before your closing, you should get a final closing disclosure that has everything locked in here.

Why just an estimate?

And I know it can be really confusing because you're under contract for the house and you're like, "how do you guys not know how much I need to bring to the closing table?". It is because there are multiple people who are charging different things when you're purchasing a home and not everybody has the exact numbers ready at the time that you sign for your purchase contract. That's why it's really good to have a loan officer who can help explain the details of these fees to you. So you can have a really solid understanding of everything that's going on here.

Double check your information

So, on your Loan Estimate, there will be a Date Issued, Who's the applicant, so just double-check your name, your address also double-check the property as well. So make sure that all the details in there are correct. Because there can be some clerical errors that can happen, and of course we don't want to purchase and get a mortgage on a house that we're not buying.

Sale Price and Loan Amount

Regarding Sale Price, this would you agree to on your purchase contract. This is how much are you buying the home for, it's going to be listed right there. Then right beneath this is our loan amount. The difference between the sale price and the loan amount is normally what our down payment is.

If you're using a loan like FHA or VA, and there's a funding fee, that's going to be included in your total loan amount as well. So it's important to keep in mind. But for most people, this is going to be what your down payment is.

The difference between the purchase price and the loan amount, because what ends up happening is at the closing table, the lender provides the loan amount then you provide the down payment. that money gets grouped and given to the seller as the sale price.

Loan Term

So now, we have our loan term. How long is your loan for 30 years is common. For most people, it might be 15 years, might be 20 years.

What is the purpose

The purpose of purchase refinance is normally should be listed.

What is Fixed-Rate or Adjustable-Rate

Also, is this a fixed rate or an adjustable-rate loan? So a fixed-rate loan means that after closing your rate, it will never change your principal and interest. Meaning, it will never change for the remainder of your loan. If it's an adjustable-rate mortgage, that actually means that the rate can change in the future. A lot of people before the housing crash were in adjustable-rate mortgages, their interest rate went up so high, their payment went up so high. They weren't able to afford it. And that's how a lot of people had to default on loans before the housing crash. So be careful that if you do get into an adjustable-rate mortgage, you are very certain and you understand all of the complexities and the details of an adjustable-rate mortgage fixed rate at the moment is likely going to be your best option.

Loan Types

What is the type? We look at conventional, FHA, VA, another option in here could be something like USDA or maybe a portfolio loan.

Loan ID

Loan ID is just tracking your loan and in the database, nothing too important to keep in track there.

Rate Lock

This one is really important. So the rate can be affected in two ways. There is the locking portion, and then there is the fixed portion, and these are referencing to what happens before closing and after closing. So before closing your rate can either be floating or locked. If it is floating, that means it's changing with the market, right? If you look at what are interest rates today, that's because interest rates actually change multiple times per day, depending on what's happening in global markets.

And so when it's floating, your interest rate might be given to as a quote, but it's not locked in yet. And so what you want to do is talk with your loan officer about when is the best time to lock it, locking it in means that it will then be fixed and will not change before closing. So it can either be floating, then it gets locked, then you have closing. Then after that, if you have a fixed-rate loan, it will never change. If you have an adjustable-rate loan, it may change depending on the terms.

Rate Lock do expires!

Locks do expire. So it's important to keep that in mind. And so if you're a loan officer who does choose to lock upfront, you need to make sure that the lock expiration date happens on or after the closing date because your rate lock can't expire before closing, you have to hit closing. The closing date actually finalizes the loan before your rate lock expires. If you don't, there often is an extension charge to extend the rate lock.

Interest Rate

We also have our interest rate. This is one of the big numbers that most people are focused on. So we have 3.875 which is an older loan estimate from the CFPB. So we might see some higher rates on there.

Can this amount increase after closing?

Something interesting about the second column is "Can this amount increase after closing?" is really helpful to look at as well. Our loan amount can not increase after we close and interest rate can not increase after we closed. If you had something like an adjustable rate mortgage, that might be the case there.

Monthly Principal & Interest

Now we have our monthly principal and interest. This is what the lender charges us for the loan itself and this can not increase up to closing.

Prepayment Penalty

Prepayment penalty. Both of these options are what I call risky features.

So prepayment penalty, on this loan, it says, "yes". So basically what that means is that if you pay off the mortgage early, there could be a penalty to it. Most loans today don't have a pre-payment penalty, but it's good to just double-check for this.

What's a balloon payment?

Balloon payments are risky because basically would say you have the loan for five years, and then after five years, you have to pay the full thing off in one lump sum.

That's a risky feature because you don't want to get into this and then realize you don't have the money in five years or 10 years or whatever that balloon payment is to then be able to pay off this mortgage. So normally we want both of these to say "No". 

Projected payments

What's happening in years of 1 through 7 (estimated total is higher )and 8 through 30 (estimated total is lower). So why would these be different here? The main reason is the change in mortgage insurance. So fixed-rate loans, principal, and interest stay exact. What did change was mortgage insurance actually dropped because there was 20% equity in the home and that's where conventional mortgage insurance would fall off.

Something like an FHA loan, you're likely not going to see that fall off unless you put 10% down. For VA loans, that won't have a monthly mortgage.

Estimated Escrow

So these are going to be things like your taxes and your homeowner's insurance. Now, these can change. The lender does not charge you insurance, and the lender does not charge you taxes. Those are set based on the insurance company you choose and the county that you're in as well. And so sometimes people will say, "Oh my gosh, my mortgage payment went up. Why did the lender charge me extra money?". It's not taxes went up. Those are things you have to take up with your county. The lender will not change your taxes for you.

Estimated Total Monthly Payment

So this then tells us our estimated total monthly payment. This is what the lender is going to charge you every single month, either put this on a recurring payment or you choose to pay by check or whatever each month. This is the number you need to be really comfortable with and make sure you can pay every single month for your mortgage. Also, considering that you still need to pay things like utilities and any maintenance costs for your home.

Estimated Taxes, Insurance & Assessments

This is a breakdown of what is in your escrow account. This includes Property Taxes, Homeowners Insurance. An escrow account is basically where the lender is going to collect these from you monthly and they will then go pay off those fees for you. Because for instance, property taxes normally are paid semi-annually. So instead of you having to pay a chunk of taxes twice a year, the lender will collect monthly payments from you and they will then manage the twice a month or twice a year payments.

Same with homeowners insurance. It's usually an annual premium, so instead of you paying an annual premium homeowners insurance, the time comes around to pay your premium. And you're like, "I don't have all this money", the lender is collecting that for you each month. Normally, you can waive the escrow account on a conventional loan if you have 20% down.

Cost at Closing

This is just a summary of page two.

Closing Cost Details

So let's look at our closing costs details, this is where everything is included. The only thing that likely won't be included in here for you is going to be your homeowner's inspection.

Homeowner's Inspection

Since it's an optional thing, you're not required to get it for a mortgage. This can depend on the lender, but just keep in mind an inspection can run on average, somewhere around $500. This can change depending on if you need specialty type inspections.

A. Origination Charges

So section A, this right here are what are called origination charges. This is what the lender is going to charge. Things in section eight are not allowed to change. And so that's one of the main reasons why a loan estimate exists is so that a lender can't say, yeah, it's going to cost this much. And then you get to closing and it's a bunch more.

So if the lender says section eight costs are only going to be $1,800. The lender can't come back at closing and be like, "Oh, actually it's 3000". They're not allowed to do that. There's a binding to the loan estimate when they create this and they're now bound to this charge.

What are points?

Basically, points are, think of it almost prepaid interest in a way. So you can pay extra money upfront to lower your interest rate. You can also do the inverse so you can receive credit and get a higher interest rate.

So points can give you a lower interest rate and a credit can give you a higher interest rate. So sometimes people choose to pay points to lower their interest rate, that they can save some money on interest. Then you have the other fees that the lender might charge. So this lender is charging an application fee and an underwriting fee. Again, these cannot change in the future.

B. Services You Cannot Shop For

Section B. These are services you cannot shop for, basically their services that the lender doesn't provide. They're provided by another third party, but the lender is not letting you. For that service. So same thing here, the lender is held to these fees.

These are not allowed to increase exponentially on you at the closing table. So if they say 672, now it can't be $1,200 in the future. They are stuck with these fees. So you have the appraisal fee, this is going to be super common on most loans. Credit report, these are all very standard fees. Flood determination fee, flood monitoring, text service, tax status, research fee. These are all pretty common. And if you have questions about them, if you need some explanation, talk to your loan officer about, "what are these fees being charged? Help me understand why this is needed here?".

C. Services You Can Shop For

Section C. These are services you can shop for. Mainly what's gonna be included in the title.

So when you purchase a home, there's going to be a company that does a title search of your home. Basically, they're going to be managing how clean your deed is, making sure there aren't what are called title defects. So just basically making sure that the chain of ownership is clear. And so when you own your home, when you signed to purchase that home, you're going to be the sole owner. No one else is going to claim your property, which they then could contest and in court.

In here you actually can shop for this. Now, most people that I've run into don't actually shop for their own title insurance and most title companies. Aren't you, you're not going to see huge differences in cost between them.

So often they will rely on their lender's recommendation or the real estate agent's recommendation because it's good to work with a title company that could actually provide a title search report very quickly. Sometimes I can see title companies that just take a long time and the longer that takes it can put your closing in jeopardy of taking too long and then you're out of contract.

So if you do shop for your own title insurance, then the lender is not held responsible for these fees. However, if you choose the one that your lender recommends or is on your lender's list of what are called settlement providers, which will be provided in a document similar at the same time as your loan estimate, then this is going to be held within a 10% tolerance, meaning it can't charge more than 10%.

So things in here might be like a pest inspection fee, survey fee, and your title as well.

D. Total Loan cost (A+B+C)

Section D. This is just going to sum up everything that was in A, B, and C. Then we move on to other costs.

Other costs: E. Taxes & Other Government Fees

Section E recording fees and other taxes. Normally the county is going to charge money to be able to actually record the deed and the mortgage, just part of the county doing their charges.

Then we also have transfer taxes. This doesn't apply in every state. For instance, in Ohio, the buyer doesn't pay transfer taxes. However, in other states and your state as well, they might charge transfer taxes where you actually paying the tax for the transfer of the property. That's up to your own county and your own state.

The lender does not have control, but I think it's something really important to remember about your loan estimate is your lender only is controlling Section A. Everything else, your lender doesn't control. This is why it's an estimate. They're estimating all of these other third-party things. So things in here change, it's important to talk with those individual people not get frustrated at your lender because if the title fees come back different, we need to talk to the title company and not necessarily the lender about why those here.

F. Prepaids

Section F, these are prepaid. So when you do purchase a home, normally you do need to pay a year's worth of homeowners insurance upfront. On this loan estimate six months, I'm not sure exactly why, 12 months is normally the standard that is going to be in there.

Then mortgage insurance premium. If there is usually, that's not prepaid for most people unless you take that choice. Prepaid interest. This is from the time that you close until your first payment is due. So what's really interesting about mortgages is there's always going to be a full month's worth of time that you don't make a mortgage payment and mortgage payments always going to be due on the first.

So for instance, if today is the 15th of September, we're actually going to skip all of October and the first payment would be due on November 1st. But don't believe the first date is going to be listed on your loan estimate for the first payment date.

So that's for the interim interest. So you're paying interest each day that you didn't make that mortgage payment. Some people like to think of it as skipping a first mortgage payment which isn't technically true when we do the full math. You're paying the full loan over 30 years. However, you're just not having to pay the principal during that first period.

Then also property taxes. If that's being required, usually not required unless that's something required by your county.

G. Initial Escrow Payment at closing

Section G, this is your initial escrow payment at closing. If you're waving an escrow account, these numbers will be blank. However, if you do have an escrow account, normally there's a few months of homeowners insurance and taxes put into an escrow account.

At a minimum, for most lenders, there's a requirement of two months of a buffer. So the escrow account always has to have two months of each, homeowner's insurance, and property taxes. However, likely you're going to see more months collected of each because what the lender is then doing is they're creating an adjustment to see homeowner's insurance would be due next year on this date, then the next property tax date is on three months from now, and the following. So if it's due three months from now, but there's a full bill due, what they need to do is have enough in the escrow account to make that full payment over three months. So that's why they would collect more, and then usually you're going to get a proration from the seller to make up the difference.

So I hope that makes sense because if you only were in the home for three months, but they're giving a tax bill for six months, the seller then owes you three months' worth of taxes and a tax proration.

H. Other Title -Owner's Title Policy

Then you also have the owner's title policy. This is part of the title, but why is it in the other section? And the reason why is because this is optional, all of these title fees are required on the loan.

Every lender is going to require a title search. However, the owner's title policy is extra protection that you can get to help you against any future title claims that come against the home. So that's why that's optional in the other section.

Then we have the sum of E F, G, and H, and then section J shows us the total sum of all of these closing costs.

Lender Credits

Then there are also lender credits. So it can be a little confusing because lender credits and points work as an inverse relationship to each other. But the lender credits are under Section J if we had any. So, if we were getting any lender credits, then it would go below it.

Cash to Close, how much is it?

So then what happens is we're doing the final math the Cash to Close. So Cash to Close is how much do you have to write a check for and bring it to the closing table? How much does that number need to be? It's your cash to close. It's not your closing costs. It's not your down payments, cash to close. It is the bottom line figure that does that factors in your closing costs, your down payment, and any other credits that you're getting all factored together.

So what's going to do is it's going to add everything right here in the Calculating Cash to Close section. So, total closing costs are any closing costs financed. So paid from the loan amount this often will happen if you do have something with upfront mortgage insurance, like an FHA loan, VA, or USDA loan. Normally those closing costs will be listed out here, usually in section B, but then the loan amount will be increased for the same amount and you'll see how it's financed on Closing Costs Financed. So that would actually be a negative figure. So the closing costs, the amount financed, the down payment that we're paying as well, and if we remember this is actually the difference between our sale price and our loan amount.

For Deposit

So if you may, if you put an earnest money deposit that was money that you already paid, it applies as a credit towards your cash to close since it's money that you already paid.

Funds for the Borrower

If there are any Funds for the Borrower, which are usually not Seller Credit, you have a Seller Credit negotiated in your contract. That will be in the Adjustment and Other Credits. A good example of this is if there's a rebate for an appraisal. What can also happen is if a lender is locked into these fees.

What is a Tolerance Cure?

If the costs change above what the lenders are allowed to change, there can be what's called a tolerance cure where the lender actually has to pay for the overage. So estimated cash to close is also listed below. This is theoretically how much this person should expect to bring to the closing table.

And it's important to always remember, this is still an estimate. So if you're at the stage, you're under contract, you've got your loan estimate and you're like, cool, 16,000 sounds good. We're comfortable with that, but you also wanna make sure things don't change too much. It might be good to talk with your loan officer and ask them, "what could change on here?". So we have a better understanding of what to expect.

What it there are changes?

If things do change, you should be getting corrected loan estimates as you go along while being under contract.

Page 3 and what's in there

This is just telling us some additional information. At this point, we already know what kind of loan we're getting, the purchase price, the rate of the payment that we're making.

If we have an escrow account or not, how much is being included in the escrow, if there are dangerous features on our loan, and what are the closing costs, both from the lender and from everybody else, and how much do we have to bring bottom-line. We already figured out all of that.

How to know your lender thru NMLS

Now it tells us some additional information, like who is our lender, who is our loan officer. What you can actually do is you can look into your lender's NMLS number. So you can just Google search NMLS, consumer lookup type in their number, and actually, see if there are disciplinary actions against your loan officer.

Compare

If those have been taken in the past then we can do is look at the comparison. So when you're under contract, if you get loan estimates from different lenders that you're talking to, you can use this section to compare which loan offs or what lender do you want to work with. There's a really quick comparison table built-in here for your loan estimate. So that can be really interesting. If we look at three different loan estimates, what's changing between the two in five years' time. So we can take a shorter time horizon, look at this, which loan is better because it's important to remember. You're probably not going to have this loan for 30 years. Most people refinance within five to 10 years, and usually don't hold on to the loan for 30 years.

What's the APR?

So the APR (Annual Percentage Rate) is taking both the interest rates. So how much do we pay in interest, but it's also considering what did we have to pay to get the loan? So what were the finance costs? So things like, what did the lender charge? What were the appraisal costs? What were title costs along with things like mortgage insurance are all included and expressed as a total rate of the overall costs of the loan?

APR is an okay metric to compare loans, but it assumes that we're carrying the loan for 30 years. Cause it's only looking towards the very end of the loan. So the difficult measure about these loans actually changes in their cost over time. In the beginning 10 years, you might find one loan is cheaper, but in the following 20, another loan is cheaper than you're comparing APR. Doesn't take that into account. And so it's an okay metric, but don't just solely rely on APR.

Total Interest Percentage (TIP)

This can be great to help look at when you're comparing those loans. So this is the total amount of interest that you'll pay over the loan term as a percentage of your amount. They also put in some other considerations here, they can be a little bit helpful, usually not make or break on loans.

Appraisal

We can order an appraisal to determine the property's value, charge you for the appraisal and give you a copy of it even if your loan doesn't close. You can pay for an additional appraisal for your own use at your own cost. If you do that, it's not going to be considered by the lender. Only the lender can order the appraisal that they will then use for the property.

Assumption

If you sell or transfer this property to another person, we will or will not allow assumption on this loan under the original terms. There are some loans that allow you to basically transfer your mortgage to somebody else. It's called an assumption, usually not available on most loans.

Homeowners insurance

This loan does require homeowners insurance on the property, which you may obtain from a company of your choice that we find acceptable. If you end up removing homeowner's insurance, the lender can actually force place homeowner's insurance and charge you a ridiculous amount of money for that. So you do have to maintain homeowners insurance on your home, even after it closes.

Late payment

So this is saying if it's 15 days late, we'll charge a late fee of 5% of the monthly.

Refinancing

These are very common terms for most loans that I've seen refinancing this loan will depend on your future financial situation, property value, and market conditions and you may not be able to refinance this loan.

This is basically just saying that when you do get a refinance, it's not just an automatic thing. We're not just going to give you a lower rate. You do have to requalify for a new loan in the future to get a refinance.

Servicing

We intend to service your loan. If so, you'll make payments to us or we intend to transfer servicing of your loan. This has when people talk about, "Are they going to sell my loan or not?". So basically what happens is once your loan closes, you then have to make payments to somebody, and that's not always the same company that you close with.

You may have closed with lender A and you've been paying them for a year, and then your loan then gets sold to lender B. The only thing that changed is who you're paying those payments to. So you're just paying them to lender B loan terms stay exactly the same. They will never change.

Confirm Receipt

In the end there you do have to sign it to say, "Hey, I received this, I recognize that I received this loan estimate.". This is then what's going to allow everything else in the process to move forward along with another document in a very similar package of documents. So we get called an intent to proceed. And so you do have to acknowledge the loan estimate and sign an intent to proceed before anything else in your loan can move forward.

So this is the loan estimate and this is everything that you need to know about your loan. I know it can be frustrating and say, "I wish they could just give me one solid number". Unfortunately, real estate doesn't work that way. There's are a ton of people that you're going to be working with, who is going to help you close on your home. Not only do you have your real estate agent, but there's your lender and your appraiser, and the title representative. You have people in the county who are going to help record the ownership of your home. You have an insurance agent, you have an inspector. So many people helping you purchase a home. And that's why it's an estimate. All those fees are unknown until invoices start coming in and things start to get more clear as we move through the process.

At that point, you're going to get a closing disclosure. It's likely still going to have things that are a little bit estimated, but should be much closer. And then we'll get your final closing disclosure before closing that tells you exactly how much you need to bring to the closing table. Normally, what happens is a loan estimate is quoted a little bit higher than normal or higher than what actual closing costs will be.

So it's a low loan estimate, maybe another loan assessment that you get. Closing disclosure, final closing disclosure. Normally the costs are going to come down as you move through the process.

Communicate, ask your loan officer

Always feel free to ask your loan officer, "what could change? Could you help me understand what the difference is between these two loan assessments? Could you help me compare my loan estimate to my closing disclosure?. Because those documents are going to look different from each other. Feel free to ask questions to your loan officer. They're there to help you understand this document and to help you move through the process as smoothly as possible.

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