Can You Roll Closing Costs Into a Conventional Mortgage?

A conventional mortgage is a home loan not backed or insured by a government agency, instead originating from private lenders such as banks or credit unions. These loans adhere to guidelines set by entities like Fannie Mae and Freddie Mac. Closing costs are various fees and expenses paid at the end of a real estate transaction to finalize the mortgage and transfer property ownership. Homebuyers often wonder if closing costs can be included in a conventional mortgage. This is possible under specific conditions and through certain mechanisms.

What Are Closing Costs?

Closing costs are fees associated with a mortgage loan and real estate purchase. These expenses are distinct from the loan principal and the down payment. Buyers pay most closing costs, which can range from 2% to 5% of the loan amount, though they can sometimes be higher, up to 6%.

Common categories of closing costs include:

Lender fees: Cover loan origination and underwriting, such as origination, application, and underwriting fees. Discount points, which borrowers can pay to reduce their interest rate, also fall under lender fees.
Third-party fees: Paid to external professionals involved in the transaction, including appraisal fees for valuing the property, title insurance costs to protect against ownership disputes, attorney fees, and recording fees for official document registration.
Prepaid items: Often include initial payments for property taxes and homeowner’s insurance premiums, which are typically held in an escrow account.

Strategies for Including Closing Costs in Your Mortgage

Including closing costs in a conventional mortgage involves increasing the loan amount to cover these expenses. This approach means the total loan principal is higher, and you finance the closing costs over the mortgage term, avoiding significant upfront cash outlays. However, this strategy is subject to loan-to-value (LTV) ratio limits, as the combined loan amount, including any rolled-in costs, must remain within the lender’s permissible LTV thresholds. For instance, many lenders prefer an LTV of no more than 80%, meaning borrowers should have at least 20% equity in the property, though some programs allow higher LTVs. If the LTV becomes too high, private mortgage insurance (PMI) may be required, adding to monthly costs.

Another common method is a “no-closing-cost” mortgage, where the lender covers the closing costs in exchange for a higher interest rate on the loan. While this option eliminates upfront closing expenses, the borrower effectively pays these costs over time through increased interest payments embedded in their monthly mortgage bill.

Lender credits offer a similar mechanism, where the lender provides a credit to offset some or all of the borrower’s closing costs. This credit is provided in exchange for a higher interest rate, similar to a no-closing-cost loan. These credits reduce the cash needed at closing, achieving a comparable effect to rolling costs into the loan without directly increasing the principal amount.

Financial Impact of Including Closing Costs

When closing costs are included in the mortgage, either by increasing the principal or through a higher interest rate, there are financial consequences for the borrower. If the closing costs are added to the loan principal, the total amount borrowed increases. This larger loan amount leads to higher monthly mortgage payments and a greater total amount of interest paid over the life of the loan.

For “no-closing-cost” loans or those with lender credits, while no upfront cash is required for closing, the trade-off is a higher interest rate. This higher rate results in larger interest payments over the mortgage term, making the loan more expensive in the long run compared to paying closing costs upfront. Consequently, while including closing costs in the mortgage can ease the immediate financial burden, it increases the total cost of homeownership over time.

Other Methods for Covering Closing Costs

Beyond incorporating closing costs into the mortgage, several other methods can help homebuyers cover these expenses. The most straightforward approach is paying them out of pocket using personal savings. This method avoids increasing the loan amount or incurring a higher interest rate, potentially saving money over the life of the loan. While requiring more upfront cash, it can be the most cost-effective solution in the long term.

Another common strategy involves negotiating seller concessions, where the home seller agrees to contribute a portion of the buyer’s closing costs. These concessions are capped as a percentage of the sales price, with limits varying based on the loan type and the buyer’s down payment. For conventional loans, seller concessions usually range from 3% to 9% of the purchase price, depending on the down payment amount, but cannot exceed the total closing costs.

Gift funds from eligible sources can also be used to cover closing costs. Conventional loan guidelines typically permit gift funds from family members, a fiancé, or a domestic partner. These funds must be a true gift, with no expectation of repayment, and typically require a gift letter from the donor stating the amount and their relationship to the borrower. This option can be particularly helpful for first-time homebuyers who may have limited savings for upfront expenses.