Can You Roll Your Closing Costs Into Your Mortgage?

Closing costs are fees and expenses paid at the end of a real estate transaction for a home purchase or refinance. These costs, typically ranging from 2% to 5% of the home’s purchase price, cover services like appraisals, title searches, and loan origination. It is often possible to include them in the mortgage loan itself. This approach can alleviate the immediate financial burden at closing, though it has implications for the total cost of the loan over time.

How Closing Costs are Incorporated into a Mortgage

Incorporating closing costs into a mortgage involves increasing the principal loan amount to cover some or all of these fees.

Many types of mortgage loans allow for closing costs to be rolled into the loan, each with specific provisions and limits:

• Conventional loans permit this, but are restricted by loan-to-value (LTV) ratio requirements, often requiring an LTV of 80% or less without private mortgage insurance.
• FHA loans allow most closing costs to be rolled in, including the upfront mortgage insurance premium (UFMIP), with an LTV limit of 97% or less.
• VA loans permit the VA funding fee to be rolled into the loan, and often do not have maximum LTV ratio requirements.
• USDA loans allow closing costs to be included if the home’s appraised value exceeds the sale price, using the extra loan amount to cover these costs.

However, not all closing costs are eligible to be rolled into a mortgage. Lender fees such as origination fees, mortgage points (discount points paid to lower the interest rate), appraisal fees, and title insurance fees can be included. Attorney fees and recording fees are also eligible.

Conversely, prepaid expenses, often referred to as “prepaids,” cannot be rolled into the mortgage. These include future expenses like property taxes, homeowner’s insurance premiums, and homeowner association (HOA) fees, which are required to be paid upfront to ensure coverage and establish escrow accounts.

The ability to roll in closing costs is also affected by the loan-to-value (LTV) ratio, which represents the percentage of the home’s value being borrowed. Most lenders have maximum LTV limits, ranging from 80% to 97%, depending on the loan type. If rolling in closing costs pushes the LTV above these limits, the borrower may be required to pay for mortgage insurance or might not be approved for the loan at all.

The process of incorporating closing costs into a mortgage involves discussing this option with the lender during the loan application. The lender will assess if the increased loan amount, including the closing costs, remains within the property’s appraised value and adheres to LTV and debt-to-income (DTI) requirements. If approved, the closing costs are added to the principal, and the borrower makes payments on this higher amount over the loan term.

Financial Impact of Including Closing Costs

Adding closing costs to the mortgage principal has direct financial consequences for the borrower. A higher principal loan amount translates directly into higher monthly mortgage payments. This is because the monthly payment calculation includes both the principal repayment and the interest accrued on the larger loan balance.

A larger loan amount means more interest will be paid over the life of the loan. Even if the interest rate remains the same, the total interest paid increases significantly because interest is calculated on a higher principal for a longer period, 15 to 30 years. For example, rolling in an additional $5,000 in closing costs on a $200,000 mortgage at a 3.5% interest rate over 30 years could result in $3,000 more in total interest paid over the loan term.

This increase in total interest paid means the overall cost of the home purchase becomes higher than if the closing costs were paid upfront. While it provides immediate cash flow relief, the long-term financial burden is greater.

A larger principal also impacts equity build-up in the early years of the loan. With a larger principal, a greater portion of the initial mortgage payments goes towards interest rather than reducing the principal balance. This can slow down the rate at which a homeowner builds equity in the property.

Other Ways to Cover Closing Costs

Several other methods exist for covering closing costs without increasing the loan principal. One option is paying these costs with cash. This involves bringing the necessary funds to closing, which keeps the loan amount lower and reduces total interest paid.

Lender credits are another alternative. Some lenders may offer a credit towards the buyer’s closing costs in exchange for a slightly higher interest rate on the mortgage. This trade-off means less cash is needed upfront, but the monthly mortgage payments will be higher, and more interest will be paid over the life of the loan.

Seller concessions are another strategy where a home seller agrees to pay a portion of the buyer’s closing costs as part of the negotiation. Negotiated during the purchase agreement, this can be a fixed dollar amount or a percentage of the home’s purchase price. The amount of seller concessions is limited by the loan type; for instance, FHA loans allow up to 6% of the purchase price, VA loans up to 4%, and conventional loans range from 3% to 6% depending on the buyer’s down payment.

Gift funds can be used to cover closing costs. These are monetary gifts from donors, such as family members, and can help cover various homebuying expenses. Lenders require documentation, including a gift letter stating the funds are a gift and not a loan, plus proof of funds and transfer documentation.