Closing costs are the fees charged by lenders and third parties to finalize and fund a new mortgage loan. These costs are typically due at closing and can range from 2% to 5% of the total loan amount. For homebuyers, coming up with thousands of dollars in cash for closing costs can be a challenge. This leads many borrowers to consider rolling closing costs into their mortgage loan.
Rolling closing costs into your loan simply means adding the costs to your overall mortgage balance rather than paying for them upfront in cash. This can be an attractive option for buyers who want to keep more money in their bank account. But is it the right choice for you? Here’s what you need to know about the pros and cons of financing closing costs into your home loan.
What Are Closing Costs?
Closing costs encompass various fees charged by lenders, attorneys, and other third parties to process, underwrite, and finalize a mortgage loan. Common closing fees include:
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Origination fee – A charge by the lender to process your loan application and underwrite the mortgage Usually 1% to 2% of the loan amount
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Appraisal fee – Pays for a professional appraisal of the home’s market value. Typically $300 to $600
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Credit report fee – Covers the cost of the lender pulling your credit report Usually under $50
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Title insurance fee – Insures the lender against claims that could affect ownership of the property. Often $700 to $2,000.
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Recording fees – Charged by local government to record the mortgage deed and other legal documents. Often under $100.
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Prepaids – Costs like homeowner’s insurance premiums, property taxes, and interest payments due at closing.
Closing costs typically add up to thousands of dollars. Coming up with the cash can be difficult, leading borrowers to look at ways to reduce out-of-pocket costs like rolling them into the mortgage loan.
How Does Rolling Closing Costs into a Loan Work?
If your lender allows it, you can simply add your closing costs to the principal mortgage balance you’ll be borrowing rather than paying the fees in cash upfront.
For example, say you’re buying a $300,000 home. You plan to make a 20% down payment of $60,000. Your closing costs add up to $6,000.
Rather than paying the $6,000 out of pocket, those costs could be added to your loan principal. So you’d borrow $246,000 instead of $240,000.
By rolling the costs in, you bring less cash to closing and finance the fees over the life of your mortgage.
Pros of Rolling Closing Costs into Your Loan
You spend less money upfront. For buyers without much cash on hand, minimizing upfront costs is often the priority. Rolling closing costs into your mortgage is one way to accomplish that.
You can keep cash in the bank. By not handing over thousands in closing costs, you preserve your liquid savings and emergency funds. This can provide comfort and financial flexibility.
May allow you to buy sooner. Rolling costs in rather than saving up for them can accelerate your timeline for purchasing if you don’t currently have the cash on hand.
Mortgage interest deduction. With a higher loan balance, you may be able to claim larger mortgage interest deductions on your taxes in the years after buying.
Cons of Rolling Closing Costs into Your Loan
Higher monthly payments. A larger loan amount means higher principal and interest payments each month. Budget carefully.
More interest paid over time. You’ll wind up paying interest on the closing costs over the life of the loan, making your total borrowing costs higher.
Less equity accumulation. With a larger loan balance, your equity will build more slowly in the early years. This can impact profit when you sell.
Potential loan qualification issues. A higher DTI ratio or LTV ratio from increased loan amount could make approval more difficult.
May require mortgage insurance. On conventional loans, rolling costs in could push your LTV over 80% and trigger PMI requirements.
As you can see, rolling in costs isn’t free money. You ultimately pay the price over the long run. Still, it can be a reasonable tactic to minimize cash needed at closing if you plan to stay in the home long enough for the benefits to outweigh extra interest costs.
What Closing Costs Can Be Rolled into a Mortgage?
Most lenders allow common fees like origination charges, title fees, and government recording fees to be rolled into your mortgage principal.
Costs that usually can’t be included are prepaid expenses (like insurance premiums and property taxes) that must be paid at closing. Talk to your lender to find out their specific policies on rolling costs in.
Lender Requirements for Rolling In Closing Costs
Lenders want to make sure your new loan amount including closing costs still fits within their underwriting standards. Two key measures they’ll look at are:
Loan-to-Value Ratio: The LTV compares your loan amount with the home’s appraised value. Most lenders cap LTVs at 80% without requiring private mortgage insurance. Rolling in costs can’t push your LTV too high.
Debt-to-Income Ratio: The DTI measures your total monthly debt payments in relation to your gross monthly income. Standard DTI limits range from 36% to 50%. Your new payment can’t be too much of a stretch.
Provided your ratios stay within approved ranges and you qualify for the larger loan amount, the lender should allow you to roll in your closing fees up to their permitted limit.
Alternatives to Paying Closing Costs Upfront
If rolling closing costs into your mortgage doesn’t work for you, here are a few other options for minimizing out-of-pocket costs:
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Negotiate seller concessions: Ask the seller to cover some of your closing costs by giving credits at closing.
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Take a higher rate: You can opt for a slightly higher interest rate in return for lender credits to cover closing costs.
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Use down payment assistance: Many programs for first-time buyers provide grants or loans to help fund down payments and closing costs.
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Borrow from family: Consider an interest-free family loan or gift funds from parents or relatives.
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Reduce down payment: Putting down less upfront leaves more for closing costs. Explore low down payment mortgage options.
The Bottom Line
Rolling closing costs into your mortgage loan lets you minimize cash needed at closing. But you pay for this over time through higher loan payments and interest costs.
Carefully crunch the numbers to see if it makes sense for your unique situation. And always compare any alternatives that may allow you to buy your dream home with less strain on your down payment funds.
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What does it mean to roll closing costs into your loan?
Including closing costs in your loan — or “rolling them in” — means you are adding the closing costs to your new mortgage balance.
This is also known as financing your closing costs. Lenders may refer to it as a “no-cost refinance.”
Financing your closing costs does not mean you avoid paying them. It simply means you don’t have to pay them on closing day.
If you don’t want to empty your savings account at the closing table — and if your new mortgage rate is low enough that you’ll still save money — financing your closing costs over the term of your mortgage might be a good strategy.
But the big downside is that you end up paying interest on your closing costs, which makes them more expensive in the long run.
So if you’re able to pay closing costs in cash, that’s typically the best move.
How else can I avoid paying closing costs?
As we mentioned above, you can usually roll closing costs into your mortgage when purchasing or refinancing.
But there are other ways to reduce your closing costs when buying a home. Here are some options to consider:
Ask about lender credits or fee waivers: Some lenders offer incentives, such as credits or fee waivers, to attract borrowers. It’s worth inquiring with different lenders about any potential cost-saving options they may have available.
Negotiate with the seller: Depending on the market conditions and the seller’s motivation, you may be able to negotiate with the seller to cover all or a portion of the closing costs. This is known as a seller concession or closing cost credit. It essentially involves the seller deducting an agreed-upon amount from the sales price to offset the buyer’s closing costs.
Shop around for service providers: When it comes to certain services like appraisals, inspections, and title insurance, you may have some flexibility in choosing the providers. By shopping around and comparing quotes from different companies, you may be able to find competitive rates and potentially save on these costs.
USDA borrowers can roll closing costs into their USDA loan if the appraised value is higher than the purchase price. More on that here.
Can Closing Costs be Rolled into a Mortgage Loan?
FAQ
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