Does an FHA Loan Cover Closing Costs?

Buying a house is an exciting milestone in life. However, the process can also be daunting, especially when it comes to figuring out how to pay for everything. One major expense to prepare for is closing costs, which are fees charged to process and finalize your mortgage.

If you’re considering an FHA loan, you may be wondering: Does an FHA loan cover closing costs? The short answer is, sometimes. FHA loans can help cover closing costs in a few ways:

FHA Allows Seller Credits Toward Closing Costs

One way FHA loans can cover closing costs is through seller credits. With an FHA-backed mortgage, the seller can pay up to 6% of the home’s selling price toward the buyer’s closing costs. For example, if you buy a $300,000 house, the seller could contribute up to $18,000 for your closing costs.

Seller credits are not guaranteed, however. It depends on the real estate market and whether you can negotiate credits with the seller. But the FHA program allows this option, which is more flexibility than conventional loans provide.

You Can Finance Closing Costs Into Your FHA Loan

Another option is rolling closing costs into your mortgage loan. Instead of paying costs upfront, they get wrapped into your loan amount and you slowly pay them off with interest over the life of the loan.

For example if you took out a $200000 FHA loan and had $6,000 in closing costs, you could finance it all and borrow $206,000 total. You’d pay interest on the $206,000 balance.

Financing closing costs avoids out-of-pocket expenses but increases your total interest costs over the long run. Still, it makes buying a home more affordable upfront if your budget is tight.

FHA Allows Gifts Toward Closing Costs

The FHA program lets homebuyers use gift funds toward closing costs and down payment. Gifts can come from relatives, employers, charitable organizations, or other approved sources.

There are no limits on gift amounts with an FHA loan. The main requirement is providing a gift letter confirming the funds don’t need to be repaid.

Gifts must be documented and wired directly to the closing agent, rather than given to the buyer. But they offer another way to cover closing costs if you have a generous friend or family member.

State and Local Down Payment Assistance Programs

Many states and cities offer down payment and closing cost assistance for qualifying buyers, especially first-time homebuyers. These programs provide grants, forgivable loans, or deferred loans to use toward purchase costs.

Combining an FHA loan with down payment assistance is a popular option. FHA already allows low down payments, and down payment grants can cover remaining costs.

Down payment help is contingent on meeting location-specific eligibility rules, so research programs in your state or city.

How Much Do FHA Loan Closing Costs Total?

Closing costs for FHA loans typically range from 2-5% of the purchase price. On a $300,000 home, you’d expect to pay $6,000-$15,000 in total closing costs. Here’s a breakdown of standard fees:

• Upfront Mortgage Insurance Premium: 1.75% of the loan amount goes toward upfront mortgage insurance. On a $300,000 loan, this fee would be $5,250.

• Appraisal Fee: $400-$600 for the home appraisal report.

• Credit Check Fee: $25-$50 per person for credit checks.

• Origination Fee: Up to 1% of the loan amount goes to the lender.

• Title Fees: Title search, document preparation, escrow services, and title insurance add up to around $1,000-$2,000.

• Prepaids: Home insurance premium, property taxes, and HOA dues (if applicable) need to be paid in advance at closing, typically $2,000-$5,000 total.

Shopping around for title and escrow services can help lower some of these closing expenses on an FHA loan. But the upfront MIP and prepaids are fixed costs.

Strategies to Lower FHA Closing Costs

Beyond seller credits and down payment help, a few other tips can reduce total cash needed for closing costs on an FHA loan:

• Negotiate lender fees: Compare multiple lender quotes and negotiate origination fees, application fees, or points.

• Pay discount points: Paying points upfront reduces your interest rate, saving money long-term. Each point typically costs 1% of the loan amount.

• Split closing costs with seller: If sellers won’t credit the full 6%, ask if they’ll agree to split costs 50/50 or at another agreed percentage.

• Request a lender credit: Sometimes lenders will offer a lender credit if you lock in a higher rate. Just run the numbers to see if higher payments outweigh upfront savings.

• Pay down debt: Reducing monthly debts can help you qualify for a lower rate, saving on interest costs over time.

FHA Streamline Refinance Closing Costs

The FHA streamline refinance program allows existing FHA loan holders to refinance with limited documentation and appraisal requirements. This helps lower closing costs compared to a traditional mortgage refinance.

FHA streamline refinancing comes with upfront MIP of 0.01% of the loan balance and an annual MIP of 0.55% to 1.05%. Closing costs average around $2,500 compared to $6,000 or more for standard refinancing.

Seller credits don’t apply to refinances, but you can still roll closing costs into the new loan amount. Just be mindful of the loan-to-value ratio, as FHA has limits on how much cash you can take out with a streamline refi.

Weigh Pros and Cons Before Using FHA to Cover Costs

The bottom line is FHA loans offer more flexibility than conventional mortgages when it comes to covering closing costs. But each option has trade-offs to consider:

Pros

• Easier to buy a home with limited savings
• Lower out-of-pocket costs at closing
• May allow you to buy sooner than saving up for all costs

Cons

• Higher interest costs over loan term if financing costs
• Potentially higher monthly payments
• More debt could limit future financing options

Carefully consider both the short and long-term impacts when using an FHA loan to cover closing costs. While the program provides more options, they aren’t necessarily the best fit for every homebuyer.

Talk to a Loan Officer About Your Specific Situation

There’s no one-size-fits-all answer to whether you should use an FHA loan to cover closing costs. The right approach depends on your unique financial situation and budget.

Meet with a loan officer to discuss FHA financing options. Ask about what credits or assistance programs you may qualify for in your area.

An experienced lender can explain the costs and process to help you make an informed decision when pursuing an FHA mortgage. While the program offers flexibility, you want to be sure you choose the optimal solution for your needs.