Can You Roll Closing Costs Into a Mortgage?

When purchasing a home, buyers encounter various fees and expenses beyond the down payment. These additional charges, known as closing costs, are incurred during the final stages of a real estate transaction. This article explains how closing costs can be financed as part of a mortgage and explores other methods for covering these upfront expenses.

Understanding Financing Closing Costs

Financing closing costs means incorporating these upfront expenses into the mortgage loan itself, rather than paying them out-of-pocket at closing. This approach typically involves increasing the total loan amount to cover some or all of these fees.

When costs are financed, they are absorbed into the principal balance of the loan or accounted for within the loan’s overall structure. Closing costs often considered for financing include lender fees, such as origination and underwriting charges, as well as third-party expenses like appraisal fees, title insurance premiums, and recording fees.

Mechanisms for Rolling Costs into a Mortgage

Several methods allow for closing costs to be incorporated into a mortgage. One approach involves “no closing cost” loans, where a lender offers to cover the closing expenses. In exchange, the borrower agrees to a higher interest rate on the loan, meaning the costs are paid over time through increased interest payments rather than an upfront lump sum.

Certain government-backed loan programs, such as FHA, VA, and USDA, may permit a portion of closing costs to be added directly to the loan’s principal balance. For instance, the VA loan allows the VA funding fee to be rolled into the loan, while USDA loans may allow closing costs to be financed if the home’s appraised value exceeds the sales price. This increases the overall mortgage amount, which then accrues interest over the loan term. Conventional loans generally do not permit adding closing costs to the principal balance.

Lender credits are another mechanism where a lender provides a credit towards the borrower’s closing costs. This reduces the cash needed at closing. These credits are often provided in exchange for a higher interest rate on the loan, which means the borrower pays more over the life of the mortgage through increased monthly payments. These credits are essentially a trade-off, where immediate savings on closing costs lead to higher long-term interest expenses.

Financial Implications of Financing Closing Costs

Financing closing costs has several direct financial consequences. When these costs are added to the mortgage, the total loan principal increases. This larger principal means the borrower will accrue more interest over the life of the loan. For instance, a small increase in the principal can translate into thousands of dollars of additional interest paid over a 15 or 30-year mortgage term.

A higher loan principal or interest rate results in higher monthly mortgage payments. This can impact a borrower’s monthly budget and debt-to-income ratio. While upfront cash savings can be appealing, the long-term financial outlay increases.

Financing closing costs also affects the borrower’s initial equity in the home. Since the loan balance is higher relative to the home’s value, the borrower starts with less equity compared to paying these costs out-of-pocket. This can slow the pace of equity build-up, especially in the early years of the mortgage. The financial trade-off is between reducing immediate cash needs and incurring greater costs over the life of the loan.

Alternative Strategies for Covering Closing Costs

Beyond financing them into the mortgage, other methods exist for covering closing costs without increasing the loan amount. One strategy involves negotiating seller concessions or credits. Buyers can request that the home seller contribute a portion of their closing costs, which can significantly reduce the buyer’s out-of-pocket expenses. Loan programs, such as Conventional, FHA, VA, and USDA, typically have limits on the maximum percentage a seller can contribute, often ranging from 3% to 6% of the purchase price, depending on the loan type and down payment.

Lender credits may also be offered without necessarily increasing the interest rate. These credits directly reduce the cash required from the borrower at closing. Borrowers can also pay closing costs directly from personal savings or through gift funds.

When using gift funds, lenders generally require documentation, such as a gift letter from the donor stating the amount, their relationship to the recipient, and confirming that no repayment is expected. The lender may also verify the donor’s ability to provide the funds. Additionally, some individual fees within closing costs, such as origination fees or certain title fees, may be negotiable with the lender or service provider. This negotiation can help reduce the total amount due at closing.