Can You Add Closing Costs to Your Mortgage Loan?

Closing costs are the fees charged by lenders and third parties to process and finalize a new mortgage loan. These costs are typically due at closing and can run anywhere from 2% to 5% of the total loan amount. For many homebuyers, coming up with thousands of dollars in closing costs is a major obstacle to homeownership. But what if you could simply roll these fees into the mortgage itself?

As a homebuyer and mortgage borrower, I’ve done extensive research into ways borrowers can reduce their upfront cash outlay at closing. In this article, I’ll explain when and how you can add closing costs to your mortgage loan balance, the pros and cons of doing so, key factors lenders consider, and alternative options you may want to explore first

When Does it Make Sense to Add Closing Costs to Your Loan?

Adding closing costs to your mortgage loan only makes sense under certain circumstances:

• You have limited savings for closing costs and downpayment. Financing the fees helps you get to the closing table.
• You qualify for a low mortgage rate. The savings from the rate offset the cost of added interest from a higher loan amount.
• Your loan-to-value ratio allows for adding closing costs. Keeping the LTV below 80% is ideal to avoid private mortgage insurance.
• You plan to stay in the home long-term. This makes it worthwhile to roll the costs into the loan.

I generally only recommend adding closing costs to your mortgage if you have no other way to cover these fees upfront The additional costs over the long run can really add up,

How Can You Add Closing Costs to Your Mortgage Loan?

There are a couple ways lenders can structure your loan to account for closing costs:

• Increase Loan Amount The lender increases the mortgage amount borrowed to cover closing costs This is the most straightforward way Your principal balance goes up along with your monthly payments.

• Pay a Higher Interest Rate: The lender offers a lender credit to cover closing costs in exchange for you paying a slightly higher rate. You pay more interest over the loan term.

The first option directly adds to your loan balance. The second keeps the balance the same but increases payments via the rate. I recommend crunching the numbers to see which option saves more in the long run.

Key Factors Lenders Consider

Lenders determine if you qualify to add closing costs to your mortgage by evaluating two key ratios:

• Loan-to-Value (LTV): This compares your loan amount to the home’s appraised value. Most lenders limit LTV to 80% without requiring private mortgage insurance.

• Debt-to-Income Ratio (DTI): This measures your total monthly debt payments vs. your gross monthly income. Most lenders require DTI below 50%.

If adding closing costs pushes these ratios too high, your loan application could be denied. Be conservative when estimating closing costs to keep some cushion in your ratios.

What Closing Costs Can Be Added to the Loan?

Not all closing fees can be financed into your mortgage loan. Here are some costs that lenders commonly allow:

• Origination and application fees
• Appraisal and credit report fees
• Title search and insurance fees
• Recording fees and taxes
• Initial escrow payments

Other costs like home inspections and HOA fees usually need to be paid upfront. Check with your lender to see which specific fees can be added to your loan amount.

Pros of Adding Closing Costs to Your Mortgage

• Requires less cash upfront
• Allows you to buy sooner than saving up for all costs
• Makes mortgage affordable when you have limited funds
• Keeps your emergency fund intact
• Potentially builds credit by taking on mortgage debt

Cons of Adding Closing Costs to Your Mortgage

• Increases loan amount and monthly mortgage payments
• Causes you to pay more interest over loan term
• Lowers home equity by increasing mortgage balance
• Makes it harder to refinance if home value decreases
• Can push your LTV or DTI ratios too high

As you can see, there are tradeoffs to consider when adding closing costs to your mortgage loan. Make sure you evaluate both the short-term and long-term impacts.

What Are Some Alternatives to Paying Closing Costs?

Before choosing to add closing costs to your loan, here are a few other options worth considering first:

• Negotiate with the seller: Request that the seller pays some or all of the closing costs through a closing cost credit. This avoids hiking up your own loan amount.

• Shop around: Get quotes from multiple lenders and title companies to find the lowest rates on fees. A little legwork can save hundreds.

• Use gift funds: Receive monetary gifts from relatives to be used explicitly for your closing costs.

• Look into downpayment assistance: If you qualify, there are state and local programs that provide grants or low-cost loans to cover closing costs.

• Wait and save: If you have time, slowly build up your savings by making some lifestyle tweaks. This avoids the need to finance costs.

Adding closing costs to your mortgage loan can be a double-edged sword. While it enables you to buy sooner, you end up paying much more over the long run in interest. Be strategic and run the numbers carefully to determine if it truly makes sense for your unique financial situation. With the right approach, you can keep closing costs from derailing your homebuying dreams.