Can Closing Costs Be Added to a Mortgage?

Closing costs are expenses incurred during a real estate transaction. This article explores how these expenses are typically handled and the possibilities of including them within a mortgage.

How Closing Costs Are Typically Paid

Closing costs encompass a range of fees associated with the purchase of a home. These can include loan origination fees, appraisal fees, title insurance, and recording fees.

Buyers typically pay these costs out-of-pocket at the time of closing. This traditional method requires the buyer to bring the total amount of closing costs, often ranging from 2% to 5% of the loan amount. This cash payment covers all the various charges. This direct payment approach remains the standard expectation for most home purchasers.

Methods to Include Closing Costs in Your Mortgage

While typically paid out-of-pocket, several methods exist to finance or offset closing costs through the mortgage transaction. One common approach involves lender credits. With this option, the lender agrees to cover some or all of the buyer’s closing costs in exchange for a slightly higher interest rate on the mortgage. This means the costs are not directly added to the loan principal, but rather spread out and paid over the loan’s term through increased monthly interest payments.

Certain government-backed loan programs specifically permit some closing costs to be incorporated into the loan amount. For instance, VA loans allow the VA funding fee to be financed directly into the loan principal. FHA loans allow some prepaid expenses and certain closing costs to be financed. USDA loans also allow the guarantee fee to be financed.

Conventional loans generally do not permit standard closing costs like appraisal fees or title insurance to be directly added to the principal balance. However, buyers might finance “discount points” as part of the loan amount. A buyer might also negotiate seller concessions, where the seller agrees to pay a portion of the buyer’s closing costs. These concessions reduce the cash needed at closing.

Key Considerations When Financing Closing Costs

Financing closing costs, whether through lender credits or by rolling them into the loan, significantly impacts the overall cost of the mortgage. When closing costs are incorporated, either the loan principal increases or the interest rate rises. This results in higher monthly mortgage payments and a greater amount of interest paid over the entire life of the loan. This can mean paying thousands more in interest over the loan term.

A larger initial loan amount due to financed closing costs also affects the borrower’s initial equity in the home. Starting with a higher loan balance means less immediate equity.

Financing closing costs can also influence loan qualification requirements. Lenders assess debt-to-income (DTI) ratios and loan-to-value (LTV) limits. A higher loan amount or monthly payment resulting from financed closing costs could push these ratios beyond acceptable limits, affecting a borrower’s ability to qualify. Borrowers should carefully weigh the immediate benefit of reduced out-of-pocket expenses against the long-term financial implications of increased total costs and reduced initial equity.