Can I Roll Closing Costs Into My Conventional Mortgage?

Purchasing a home often involves securing a conventional mortgage, which is a loan not backed by government agencies like the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). These loans are typically offered by private lenders and often adhere to guidelines set by Fannie Mae and Freddie Mac. Beyond the agreed-upon purchase price, homebuyers also face additional expenses known as closing costs, which are fees and charges due at the close of the real estate transaction.

Understanding Closing Costs

Closing costs encompass various fees incurred during the finalization of a real estate transaction. These expenses typically cover the services and processes required to transfer property ownership and finalize the mortgage loan. Generally, closing costs range from 2% to 6% of the loan amount. For instance, on a $300,000 loan, closing costs could range from $6,000 to $18,000.

Common categories of closing costs include lender fees, such as loan origination and underwriting fees, which cover administrative costs. Other typical costs involve appraisal fees to determine the home’s value, title insurance to protect against defects in the property title, and recording fees charged by local governments to officially register new ownership.

The Concept of Financing Closing Costs

“Rolling” closing costs into a conventional mortgage means increasing the principal amount of your mortgage loan to cover these upfront expenses. This allows a homebuyer to avoid paying these costs out-of-pocket at closing. Instead, the total loan amount becomes the home’s purchase price minus the down payment, plus the financed closing costs.

This does not waive costs; rather, they are absorbed into the long-term debt. For example, if a home costs $300,000, you make a $60,000 down payment, and closing costs are $9,000, instead of borrowing $240,000, you might borrow $249,000. This increases your overall debt, repaid over the mortgage term, usually 15 or 30 years.

Lenders may permit this financing, depending on their specific policies and the loan-to-value (LTV) limits. The LTV ratio compares the loan amount to the home’s appraised value. Financing closing costs directly impacts this ratio, as it increases the borrowed amount.

Conventional loans, particularly those conforming to Fannie Mae and Freddie Mac guidelines, have strict LTV requirements that influence how much can be financed. These limits are in place to manage the lender’s risk. Therefore, financing closing costs is not universally available and is subject to the borrower’s financial profile and the specific loan program’s criteria.

Factors Influencing the Decision to Finance Closing Costs

Financing closing costs involves financial considerations related to the loan-to-value (LTV) ratio and the total cost of borrowing. Lenders have maximum LTV limits, often 80% for conventional loans to avoid private mortgage insurance, and financing closing costs increases the total amount borrowed, pushing the LTV higher. For instance, if a home’s value is $250,000 and you finance $10,000 in closing costs, the loan amount increases, potentially leading to higher interest rates or private mortgage insurance (PMI).

Financing closing costs increases the total principal amount of the mortgage, which directly results in higher monthly mortgage payments. It also means paying interest on those financed closing costs over the loan’s life. Over a 30-year term, even a small amount financed can lead to thousands of dollars in additional interest paid. For example, financing $5,000 in closing costs at a 7% interest rate over 30 years could add approximately $12,000 in total interest paid over that period.

Lenders have specific policies and limitations on how much of the closing costs can be financed, often tied to the LTV. These policies ensure that the loan remains within acceptable risk parameters. Borrowers must understand these limitations and assess the long-term financial implications of increased interest payments versus the immediate benefit of reduced upfront cash requirements.

Alternative Approaches to Managing Closing Costs

Homebuyers have other strategies to manage closing costs without rolling them into the mortgage.

Paying Out-of-Pocket

One approach is to pay these costs out-of-pocket using saved funds. This avoids increasing the loan principal and the total interest paid over the mortgage term.

Seller Concessions

Another strategy involves negotiating for seller concessions. Sellers may agree to contribute a percentage of the purchase price towards the buyer’s closing costs, especially in a buyer’s market. For conventional loans, seller concessions are limited, ranging from 3% to 9% of the purchase price, depending on the buyer’s down payment. For example, with a down payment of less than 10%, seller contributions are often capped at 3%, while a down payment of 25% or more could allow for up to 9% in concessions.

Lender Credits

Lender credits offer another option: the lender provides a credit towards closing costs in exchange for a slightly higher interest rate. While this reduces the upfront cash needed, it increases the total interest paid over the loan’s duration. This arrangement is detailed on the Loan Estimate and Closing Disclosure documents.

Gift Funds

Gift funds from family members can also cover closing costs. Lenders require a gift letter from the donor stating the funds are a gift and not a loan. These funds can cover all or part of the closing costs, provided they meet documentation and source requirements set by the lender and loan program.