Missing the Forest for the Fees – Borrower Life-of-Loan Costs

In 2022, Fannie Mae and Freddie Mac announced plans to make it easier to buy a home and close the racial homeownership gap in the United States. Homeownership is one of the most important decisions in a person’s life and is a primary vehicle for wealth creation for the majority of households. In fact, our most recent analysis of the benefits of wealth creation from homeownership shows that for families in the bottom 20 percent of the income distribution the median net worth of home-owning households was 43 times greater than similar renting families and housing equity is the largest source of wealth for all but the highest income families in the United States. Yet, affordability now sits at historic lows and the prospect of homeownership seems more out of reach for low- and moderate-income families than ever before. That’s why the path toward equal access to economic opportunity includes ensuring access to homeownership for all.

Part of the equitable housing plans’ approach to achieving more equity includes reducing the costs and fees associated with buying a home that are often cited as a homeownership barrier for low- and moderate-income and non-white households. Specifically, based on research conducted by Fannie Mae in 2021¹, title and settlement fees have been characterized as a high-burden and regressive (costing proportionally more for low- and moderate-income borrowers) closing cost. In fact, Fannie Mae’s own update of that same research in 2022² comes to a different conclusion.

Flawed Analysis Leads to Inaccurate Conclusion on Regressivity of Title and Settlement Fees

Mota and Palim (2021) find that closing costs are more burdensome for first-time and low-income homebuyers relative to all buyers. Specifically, the set of closing costs categorized as lender fees (appraisal, origination fee, processing fee, credit report fee etc.) are the most burdensome as a percentage of sale price for low-income borrowers, followed by title and settlement charges (lender and owner title policy premiums, settlement fee, closing fee etc.). Based on the original 2021 analysis, one conclusion that may be drawn is that title and settlement fees are regressive – higher as a percentage of the sale price, the lower the borrower’s income. However, the difference in title and settlement fees (as categorized in this study) is a small fraction of a percent of the sale price, from 0.7 percent for all buyers to 0.75 percent for first-time buyers and 0.84 percent for low-income first-time home buyers.

However, this analysis failed to account for an important distinction between different fees. Some fees are fixed (not set as a percentage of loan balance or sale price), while others are variable (determined expressly as a percentage of loan balance or sale price). Because of this, it is expected that overall closing costs will increase as a percentage share of the sale price or loan balance as the sale price or loan balance decreases. For example, the appraisal is always the same amount and, therefore, represents a larger percentage the lower the price/loan. By definition, fixed closing costs are regressive and variable ones are not. This analysis lumped the fixed and variable closing costs – the lender fees and title and settlement fees – together. By doing so, the degree to which closing costs appear regressive depends on which fixed and variable fees are included and the degree to which lower-income and first-time home buyers purchase lower priced homes and get smaller loans.

Specifically for title and settlement fees, the lender and owner policy premiums are variable fees that are generally set as a percentage of the loan balance or sale price respectively. That is fundamentally different from the fixed settlement fees for the services provided to close the transaction – services directly benefitting the lender and home buyer. Therefore, any analysis of the alleged regressive nature of title and settlement fees should consider the fundamentally different nature of the title insurance product fees and the settlement service fees. Given the small range of regressive differences found in the 2021 analysis, it is quite possible that applying appropriate controls for aspects of the title and settlement fees described here could reduce or even completely remove any ‘regressiveness’ in title and settlement fees.

Title and Settlement: Neither Regressive nor a Significant Component of Closings Costs

The updated Fannie Mae research published in 2022 demonstrated a more accurate relationship between borrower groups and closing costs by examining over a million loans acquired by Fannie Mae in 2020 and controlling for a variety of borrower characteristics (ethnicity, first-time and low-income). The research found that title and settlement fees are neither regressive nor represent a significant component of the overall closing costs.

The Fannie Mae research finds that for title and settlement fees, “differences in charges across borrower groups mostly disappear (after controlling for the transaction characteristics).” What differences do exist are very small. Asian borrowers pay $13 less than non-Hispanic white borrowers (the control group); low-income borrowers pay $14 more; and first-time home buyers pay $11 less than repeat buyers. The authors say these are “not economically meaningful” differences. Given the typical borrower is paying more than $7,000 in closing costs, that might be an understatement. The research also finds that title and settlement fees increase with loan amount (a 1 percent increase in loan amount is associated with a $7.41 increase in fees). So, title and settlement fees are progressive if, as all the data suggests, higher income and repeat buyer customers buy more expensive homes with larger loans.

Less than 1% of Borrower’s Life-of-Loan Costs

But what about the share of the life-of-loan costs that title and settlement fees represent? Based on the Fannie Mae-published papers and their assumptions, the figure below shows the borrower’s average life-of-loan costs, bundled together according to who receives the fees. The figures are shown for a borrower with an average purchase price of $318,000 in 2020 and assumes that the borrowing household will keep the loan for seven years.

The borrower’s largest life-of-loan costs are the property taxes and recording fees paid at closing plus the accumulated cost of annual property taxes paid over the life of the loan. The fees paid to the mortgage-backed security (MBS) investor and lender are next with the accumulated cost of the annual interest payments made to the investor(s) that purchased the MBS bond containing the mortgage, and the lender’s net origination charges at closing plus the accumulated value of the excess interest the lender charges for profit. Homeowner’s insurance, the servicer, and even the GSE (the actual holder of the default risk on the mortgage), represent small overall costs by comparison. The title insurance premium and settlement costs (collectively title and settlement fees), along with the accumulated costs of the annual mortgage insurance premium, barely equate to 1 percent of the borrower’s total life-of-loan costs.

Peace of Mind on The Largest Transaction Most Will Make in their Lives

Buying a home is a complicated financial transaction that few families do more than once or twice. The choices are complex and the “mortgage math” can be hard to comprehend. There are many different costs and fees associated with purchasing a home with a loan and it’s often not clear who the beneficiary is, or what the reason is for the cost or fee. Some fees are charged once at closing, others over the life of the loan, and one is never sure exactly what the costs and fees will amount to until just a few days before closing.

So, what’s peace of mind worth? For less than half a percent of the purchase price, or about the monthly equivalent of an Amazon Prime subscription, title insurance protects one of the most important purchases in someone’s life. A title insurance policy protects homeowners from having to pay for the costs, legal and otherwise, of resolving any covered title claim that may reveal itself after the closing. Property ownership can be called into question over something that was missed in the title search and examination prior to closing, a boundary line dispute with a neighbor, or even fraud and forgery among other potential threats. The protection title insurance provides is most valuable to the low- and moderate-income home buyer, who otherwise could not afford the thousands or even hundreds of thousands of dollars needed to defend a threat to their ownership rights.

Missing the Forest for the Fees

Seeking to reduce the barriers to entry for low- and moderate-income and non-white home buyers is critical to their future success and wealth-building capabilities. However, not accounting for location-based customs of whether sellers and buyers pay for certain fees and the separation of the title insurance premium fee from the service fees for settlement leads to biased results and an incorrect interpretation of the impact on low- and moderate-income and non-white home buyers.

The updated Fannie Mae 2022 analysis does indirectly control for these considerations and, ultimately, finds that there is no economically meaningful difference across borrower groups in title and settlement costs. The study also aptly notes the distinction between fees paid for the benefit of the lender and fees paid for insurance or services directly for the benefit the borrower. Attempting to provide alternatives to the owner’s title insurance policy, which is only one relatively small variable, non-regressive fee directly covering the borrower, is missing the forest for the fees. There are many larger life-of-loan costs that provide no benefit to the borrower that serve as more significant potential barriers to entry for low-income home buyers. The thought, effort, and thorough analysis that Fannie Mae’s own research provides is appreciated and welcome for the benefit of future policy-making efforts.

1. Mota, N., & Palim, M. (2021). Barriers to Entry: Closing Costs for First-Time and Low-Income Homebuyers.
2. Begley, J., & Palim, M. (2022). Mortgage Costs as a Share of Housing Costs—Placing the Cost of Credit in Broader Context. SSRN Electronic Journal.