Can I Put Closing Costs Into My Mortgage?

When purchasing a home, potential buyers often focus intently on the down payment and the monthly mortgage payment. However, another significant financial consideration arises during the transaction: closing costs. These are a collection of fees and expenses incurred at the final stage of a real estate purchase or refinance. Many prospective homeowners frequently inquire whether these substantial upfront costs can be integrated into their mortgage loan.

Understanding Closing Costs

Closing costs represent the various fees and expenses that buyers and sellers pay to finalize a real estate transaction. They cover services and charges related to the loan, the property, and the transfer of ownership. Average closing costs for buyers generally range between 2% and 5% of the total loan amount or home’s purchase price. For example, on a $300,000 home, these costs could range from $6,000 to $15,000.

Common examples of closing costs include:
Loan origination fees for processing the mortgage application.
Appraisal fees for assessing the home’s market value.
Title insurance protecting against property title defects.
Recording fees for registering the new deed and mortgage.
Attorney fees.
Escrow setup fees for managing property taxes and homeowner’s insurance.
Prepaid items, such as initial property taxes and homeowner’s insurance premiums, collected to establish an escrow account.

How Closing Costs Can Be Rolled Into Your Mortgage

One way to manage closing costs without paying them upfront is through lender credits. A lender may offer a credit towards your closing costs. In exchange, the borrower agrees to a slightly higher interest rate on the mortgage loan. This means the borrower repays these costs, plus additional interest, over the life of the loan through higher monthly payments.

Another method involves increasing the principal loan amount to cover a portion of the closing costs. While this reduces the immediate out-of-pocket expense, it simultaneously increases the total amount borrowed and the monthly mortgage payment. Interest will accrue on these rolled-in costs for the entire loan term.

Eligibility and limitations for rolling closing costs into the loan vary by loan program. Conventional loans allow this, but the total loan amount, including rolled-in costs, must remain within conforming loan limits and meet specific loan-to-value (LTV) ratio requirements, not exceeding 80% to 90% of the home’s appraised value. For FHA loans, most closing costs can be rolled in, subject to the maximum LTV ratio of 96.5%. VA loans are unique; only the VA funding fee can be rolled into the loan amount, with other closing costs paid upfront or covered by seller concessions or lender credits.

Alternative Strategies for Covering Closing Costs

Beyond rolling costs into the mortgage, several other strategies exist for covering closing expenses. One common approach involves seller concessions, where the home seller agrees to pay a portion of the buyer’s closing costs as part of the negotiation. Loan programs set specific limits on these concessions; for instance, conventional loans may allow 3% to 9% of the purchase price depending on the buyer’s down payment, while FHA loans permit up to 6%, and VA loans allow up to 4%.

Gift funds offer another option, allowing buyers to receive financial contributions from family members or other eligible sources to cover closing costs. Lenders require specific documentation for gift funds, including a gift letter stating the funds are a gift, evidence of transfer, and the donor’s ability to provide the gift. Acceptable donors and documentation requirements can vary by loan type, such as conventional, FHA, or VA loans.

The most straightforward method for covering closing costs is paying them directly out-of-pocket using personal savings. This approach avoids increasing the loan amount or interest rate, thereby minimizing the total cost of the mortgage over time. However, it requires having sufficient liquid funds available in addition to the down payment.

A “no-closing-cost” mortgage provides an alternative where the lender covers the closing costs. While the borrower does not pay these fees upfront, the costs are not eliminated; instead, they are recouped by the lender through a higher interest rate on the loan or by adding them to the loan principal. This means the borrower still indirectly pays these costs over the loan’s duration, resulting in a higher total cost compared to paying them directly at closing.

Financial Considerations of Your Choices

The decision of how to handle closing costs impacts both your monthly mortgage payments and the total cost over the loan term. When closing costs are rolled into the mortgage, either by increasing the principal or accepting a higher interest rate, the monthly payment will be higher than if those costs were paid upfront. For example, a slight increase in the interest rate can lead to thousands of dollars in additional payments over a 30-year loan term. A larger loan amount due to rolled-in costs also means more interest accrues on the increased principal over time.

Paying closing costs out-of-pocket, or utilizing seller concessions or gift funds, results in a lower principal balance and a lower interest rate, leading to reduced monthly payments and a lower total cost over the life of the loan. While this requires more cash upfront, it can provide long-term savings by minimizing the amount of interest paid. This also helps build equity faster, as more of each payment goes towards reducing the principal rather than covering interest on rolled-in costs.

Evaluating these options requires an assessment of your personal financial situation, including available cash reserves and long-term financial goals. If preserving cash for other immediate needs, such as home repairs or an emergency fund, is a priority, rolling costs into the mortgage or opting for a “no-closing-cost” loan might be appealing despite the higher overall expense. Conversely, if minimizing the total cost of the loan and building equity quickly are important, paying closing costs upfront or negotiating seller concessions may be the more financially advantageous choice.