When you are buying a home, one of the biggest upfront costs you will encounter are closing costs. Closing costs refer to the various fees charged by lenders, attorneys, and other third parties to process, underwrite, and close the mortgage loan and real estate transaction.
These costs are in addition to your down payment and can run into the thousands of dollars. Since closing costs can be a significant barrier for many homebuyers, especially first-time buyers, you may be wondering if there is any way to include them in your mortgage.
Yes, closing costs can be included in a mortgage. This is known as financing your closing costs. Many lenders allow the addition of an estimated amount for closing costs to the loan amount, either by increasing the mortgage amount to cover these costs, building them into the loan, or offering a lender credit to cover specific fees.
In this article, we’ll look at:
How closing costs affect your mortgage
If you can roll closing costs into your loan
The pros and cons of including closing costs
Other options for covering closing costs
Tips for estimating and reducing your closing costs
This will help you determine if absorbing closing costs into your mortgagecould be the right move for you.
How Do Closing Costs Affect Your Mortgage?
Closing costs impact your mortgage in a couple of key ways:
They increase your total mortgage amount. If closing costs are included, you will borrow more money.
They may increase your monthly mortgage payments. A higher loan amount means higher principal and interest payments.
They affect your loan-to-value (LTV) ratio. LTV compares the mortgage amount to the home’s value. A higher LTV usually requires more mortgage insurance.
They influence the interest rate you pay. Higher loan amounts sometimes mean a slightly higher rate.
As a result, homebuyers need to carefully weigh if rolling closing costs into the mortgage makes financial sense for their situation.
Can You Include Closing Costs in Your Mortgage?
The good news is – yes, you typically can include closing costs in your mortgage loan. This is referred to as financing your closing costs.
Many mortgage lenders allow you to add an estimated amount for closing costs to your loan amount. There are a few ways lenders can handle this:
They can increase the mortgage amount to cover closing costs.
Instead of requiring mortgage points upfront, lenders can build them into the loan.
Lenders can offer a lender credit to cover specific fees.
However, there are limits on how much in closing costs you can finance:
The total mortgage amount still has to fit lending guidelines.
Your debt-to-income ratio and LTV ratio need to stay within limits.
The appraised value has to support the higher loan amount.
What Are the Pros and Cons of Including Closing Costs in Your Mortgage?
Should you actually finance closing costs or pay them upfront? Here are some key pros and cons to weigh:
1. Pros of Including Closing Costs in Your Mortgage
Preserves cash. You avoid tying up thousands in closing costs to bring to closing. This preserves cash for the down payment or other costs.
Lower barriers to entry. Rolling fees into the loan lowers the total cash needed upfront, which can help first-time or budget-conscious homebuyers.
Spreads costs over time. Including closing costs allows you to amortize the costs over the mortgage term through your monthly payments.
2. Cons of Including Closing Costs in Your Mortgage
Higher monthly payment. With a larger mortgage amount, your principal and interest payment will be higher.
More interest paid. You’ll pay more in total interest over the loan term on the higher balance.
Higher LTV. A higher loan amount means a higher LTV, which could require mortgage insurance.
Slightly higher rate. On some loan programs, larger loan amounts mean slightly higher interest rates.
As you can see, the pros of rolling closing costs into your mortgage center around upfront affordability, while the cons relate to higher long-term costs.
What Other Options Do You Have for Paying Closing Costs?
Beyond including closing costs in your mortgage, here are a few other options buyers utilize:
1. Paying Out-of-Pocket
Many homebuyers cover closing costs with their own cash savings, especially if they have enough set aside beyond the down payment. This avoids adding to the mortgage balance and keeps interest costs lower.
However, as noted above, paying cash upfront isn’t feasible for everyone. You’ll need to factor in your full budget.
2. Seller Concessions
In some markets, it’s common for the seller to offer a credit toward the buyer’s closing costs, typically 2-5% of the purchase price. This can save you thousands on costs.
However, seller concessions may not be an option with all transactions.
3. Lender Credits
As mentioned, some lenders will offer lender credits toward specific fees like the appraisal or origination charges to win your business. These credits lower your out-of-pocket costs.
4. No-Closing-Cost Mortgages
Some lenders offer special mortgage products featuring no upfront closing costs, or limited costs. Often called “no-closing-cost” or “no-cost” loans, the lender covers fees or provides a credit.
The tradeoff is often a higher interest rate or mortgage points paid via a higher rate. So you’ll want to run the numbers to see if these mortgages make sense versus paying some closing costs upfront.
5. Down Payment Assistance Programs
First-time homebuyers with lower incomes may qualify for down payment assistance programs offered in their state or locality. Some programs can help cover closing costs too.
If you’re eligible, utilizing down payment help can offset what you need to pay in closing costs out-of-pocket or finance into the loan.
As you can see, you have several options to limit how much you pay upfront for closing costs. Take time to explore which path or combination makes the most financial sense.
How to Estimate Your Closing Costs
To determine if including your estimated closing costs into the mortgage fits your budget, you first need to know approximately how much they’ll be.
Closing costs can vary by location, lender fees, and other factors. But on average, you can expect to pay 2-5% of the home’s purchase price in closing costs. Some typical fees include:
Origination fees – 1%+ of loan amount
Appraisal fee – $300 to $500+
Credit report fee – $25 to $50
Title fees – $700+
Recording fees – $50 to $150
Homeowners insurance – 12 months premium
Property taxes – 2+ months
Prepaids – Homeowners insurance and taxes
To get a more customized estimate, potential homebuyers can review the Loan Estimate or use an online closing cost calculator. This helps you budget for costs.
Understanding the Loan Estimate and Closing Disclosure Forms
Two important forms also give key insights into your closing costs:
Loan Estimate: This form is provided to mortgage applicants within 3 business days of applying. It shows an itemized estimate of your closing costs and fees.
Closing Disclosure: You receive this form at least 3 business days before closing on your home. It shows your final closing costs and loan details.
Reviewing these forms carefully helps you accurately budget for closing costs and determine if you want to finance them into your home loan.
When Should You Consider Including Closing Costs in Your Mortgage?
In light of the pros and cons, here are some good scenarios when absorbing closing costs into your mortgage could make sense:
You have limited savings beyond your down payment funds.
You qualify for a preferable interest rate and loan program by financing closing costs.
You aim to keep your monthly mortgage payment affordable.
You plan to stay in the home long enough to recoup the higher costs over time.
On the other hand, paying costs upfront makes more sense if:
You have enough extra savings set aside beyond your down payment amount.
You want to minimize interest charges over your loan term.
You are borrowing close to your lender’s LTV limit already.
Take time to consider your full financial picture and loan options before deciding.
Tips for Reducing or Managing Your Closing Costs
Here are a few final tips for minimizing the impact of closing costs:
Shop lenders and compare quotes on loan fees and closing costs. As you compare, weigh interest rates and other tradeoffs.
Seek out loan programs like VA loans or USDA loans with limited fees.
If allowed, pay discount points for a lower rate to reduce interest charges long-term.
Ask your lender about any lender credits they can provide to offset specific fees.
See if the seller can offer a credit toward your closing costs in the purchase contract.
Apply for down payment assistance programs that include help with closing costs.
Avoid originating a new loan during high-cost seasons, like spring.
Closing costs are a key factor to consider when getting a mortgage loan to finance a home purchase. While closing costs can be rolled into the mortgage in many cases, this route comes with tradeoffs. Carefully weigh the pros and cons and explore all options to develop a closing cost strategy that fits your budget and financial needs.
Frequently Asked Questions(FAQ)
Are closing costs subtracted from mortgage?
Closing costs are fees associated with the purchase of a home, such as title insurance, attorney fees, and recording fees. These costs are typically paid by the seller at the closing of the transaction, and are typically not subtracted from the mortgage.
Is it OK to ask seller to pay closing costs?
It is generally acceptable to ask a seller to pay closing costs when purchasing a home. This may be done as a negotiation tactic during the home buying process, as the seller may be willing to contribute to closing costs in order to make the sale more attractive to potential buyers. However, it is important to keep in mind that the seller may not always be willing to pay closing costs, so buyers should be prepared to cover these costs themselves.
What if you are short on closing costs?
If a borrower is short on closing costs, they may be able to cover the difference by rolling the costs into the loan, having the seller contribute, or obtaining a loan from a lender to cover the costs. Additionally, borrowers may be able to take advantage of closing cost assistance programs offered by state and local governments, or by their lender. Lastly, borrowers may also be able to negotiate with the seller to cover some of the closing costs.
Can you roll a down payment into a mortgage?
Yes, it is possible to roll a down payment into a mortgage. This is done by taking out a loan for the full amount of the purchase price of the home, including the down payment. This type of loan is referred to as a “piggyback loan,” which is a combination of a first mortgage and a second mortgage. The second mortgage covers the down payment and is typically at a higher interest rate than the first mortgage.