Can You Finance Closing Costs With an FHA Loan?

Federal Housing Administration (FHA) loans offer an accessible path to homeownership. These government-backed mortgages are particularly popular among first-time homebuyers due to their more flexible qualification requirements. Beyond the initial down payment, purchasing a home involves various additional expenses known as closing costs. This article clarifies how these costs are managed with an FHA loan.

Understanding FHA Closing Costs

Closing costs represent the various fees and expenses paid by the buyer and seller at the culmination of a real estate transaction. They are distinct from the down payment. For FHA loans, closing costs typically range between 2% and 6% of the home’s purchase price, varying based on location and the specific services involved.

A significant FHA-specific closing cost is the Upfront Mortgage Insurance Premium (UFMIP), which is 1.75% of the loan amount and is generally paid at closing. Common closing costs include loan origination fees, often between 0.5% and 1% of the loan amount. Buyers also typically pay for an appraisal fee and a credit report fee.

Other expenses include title insurance premiums, covering both the lender and the owner against title defects, and escrow fees for managing the closing process. Recording fees are charged by local governments to register the new deed and mortgage. In some areas, attorney fees may apply for legal services during the transaction. Buyers often prepay items such as property taxes and homeowner’s insurance premiums, which are typically held in an escrow account.

FHA Loan Financing Rules for Closing Costs

FHA loans generally do not permit most closing costs to be directly financed into the loan amount. This policy helps maintain a conservative loan-to-value ratio, a core principle of FHA lending. By limiting the financed amount to the home’s value, the FHA aims to protect borrowers from excessive debt and the loan program.

While direct financing of most closing costs into the base loan is typically not allowed, there is a notable exception for the Upfront Mortgage Insurance Premium (UFMIP). Borrowers have the option to finance the entire UFMIP into their FHA loan amount, rather than paying it all at closing. This option only applies to the full UFMIP amount, as partial payments are not permitted. Some lenders may also offer “no-closing-cost” FHA loans, where the lender covers these fees in exchange for a slightly higher interest rate, an indirect financing method.

Methods for Covering FHA Closing Costs

Since most closing costs cannot be directly financed into the FHA loan, several strategies exist to help borrowers cover these expenses. These methods provide flexibility and can reduce the out-of-pocket funds required at closing.

One common approach involves seller concessions, where the seller agrees to pay a portion of the buyer’s closing costs. FHA guidelines permit sellers to contribute up to 6% of the lesser of the sales price or appraised value. These concessions can cover loan origination fees, pre-paid items like property taxes and homeowner’s insurance, and discount points to lower the interest rate. Seller concessions cannot be applied towards the borrower’s minimum down payment.

Borrowers can utilize lender credits, offered by the mortgage lender to offset closing costs. In exchange, the borrower typically accepts a slightly higher interest rate. This option benefits those who prefer lower upfront costs, though it results in higher monthly payments. Lender credits, combined with other concessions, cannot exceed total closing costs.

Gift funds are another option for covering FHA closing costs. The FHA allows gifts from approved sources, such as family members, non-profit organizations, or government agencies. When using gift funds, documentation is required, including a gift letter from the donor stating the funds are a gift with no expectation of repayment. Lenders verify the source, often requiring bank statements from both the donor and borrower.

Borrowers can use personal savings for closing costs. Lenders typically require funds to be “seasoned,” meaning they have been in the borrower’s account for at least 60 days. This verifies the funds are genuinely the borrower’s, not from an undisclosed loan or temporary source. If large deposits appear recently, documentation explaining their origin, such as a bonus or asset sale, may be requested.

Various down payment assistance (DPA) programs from state and local housing agencies can cover both down payment and closing costs. These programs often have eligibility criteria, such as income limits or first-time homebuyer requirements. While FHA does not directly offer these programs, many FHA loan applicants can combine their FHA loan with DPA to reduce upfront financial burden.