Can Closing Costs Be Included in an FHA Loan?

Purchasing a home involves various fees beyond the down payment, known as closing costs. For those considering an FHA-insured mortgage, a common question is whether these costs can be included in the loan amount. FHA loans are popular, especially for first-time homebuyers, due to their flexible qualification requirements. Understanding how FHA loans handle closing costs is important for financial planning.

Common FHA Closing Costs

Closing costs encompass expenses charged by lenders and third parties to finalize a mortgage loan. These fees are separate from the down payment and are typically due at closing. For FHA loans, total closing costs usually range from 2% to 6% of the loan amount, varying by property location and lender fees.

Lender fees are a significant component of FHA closing costs, such as the loan origination fee, which covers administrative processing costs. This fee can be up to 1% of the loan amount. Other lender fees include underwriting and processing fees. Third-party services also contribute to closing costs, including appraisal fees, which typically range from $400 to $700 for an FHA-approved appraiser to assess the home’s value and ensure it meets FHA standards.

Additional third-party fees include credit report fees and title insurance, encompassing both lender’s and owner’s policies to protect against future claims on the property’s title. Escrow fees, attorney fees (in states where an attorney is required for closing), and recording fees, charged by local government to document the sale, are common. Prepaid items, such as initial property taxes and homeowner’s insurance premiums for a set period, are collected at closing and placed into an escrow account.

Direct Financing of Closing Costs in FHA Loans

FHA loans generally do not permit standard closing costs to be directly financed or “rolled into” the primary mortgage loan amount. This policy differs from some conventional loan programs where certain closing costs might be added to the principal balance. This FHA guideline protects borrowers from immediately owing more than the home’s appraised value, helping to preserve equity from the outset.

The Upfront Mortgage Insurance Premium (UFMIP) is one notable exception. This mandatory, one-time FHA fee equals 1.75% of the loan amount. While due at closing, borrowers can finance the entire UFMIP into their loan, spreading this cost over the mortgage’s life. This option reduces immediate out-of-pocket expenses but results in a slightly higher loan balance and increased interest paid over time.

Alternative Ways to Cover FHA Closing Costs

Since direct financing of most closing costs is not an option for FHA loans, borrowers explore alternative methods to cover these expenses. These strategies can significantly reduce the cash required at closing.

Seller Concessions

Seller concessions are a common method, where the home seller agrees to contribute a portion of the sales price toward the buyer’s closing costs. FHA guidelines allow sellers to contribute up to 6% of the lesser of the sales price or appraised value towards the buyer’s closing costs, prepaid expenses, and discount points. These concessions cannot be used for the down payment but can cover various fees, making homeownership more accessible.

Gift Funds

Gift funds are another viable option for covering FHA closing costs and the down payment. These funds must come from an eligible source, such as a family member, a close friend with a documented relationship, an employer, or a charitable organization. Strict documentation is required, including a gift letter signed by the donor and borrower stating the funds are a true gift with no expectation of repayment. Lenders require proof of funds from the donor’s bank account and verification of the transfer into the borrower’s account.

Lender Credits

Lender credits offer a way to reduce upfront closing costs in exchange for a slightly higher interest rate on the loan. The lender covers some or all closing costs, and in return, the borrower accepts a mortgage with a marginally increased interest rate, which translates to higher monthly payments over the loan’s term. This trade-off can be advantageous for borrowers who prefer lower out-of-pocket expenses at closing but should be carefully considered against the long-term cost of a higher interest rate.

Personal Savings and Assistance Programs

Borrowers can use their own savings or liquid assets to pay for closing costs. This straightforward method requires sufficient readily available funds. Lenders will require documentation to verify the source of these funds, ensuring they are legitimate and not borrowed from an undisclosed source. Some housing assistance programs may also provide grants or loans specifically for closing costs, easing the financial burden on eligible homebuyers.