How to Get a Loan to Cover Your Home Closing Costs

Buying a home is an exciting milestone, but it also requires having enough cash on hand for expenses like the down payment and closing costs. While you may have budgeted and saved up for a down payment, closing costs can sometimes catch buyers off guard. These fees, which are typically between 3-6% of the total loan amount, cover things like appraisals, inspections, title fees and more.

If you don’t have enough money available to cover closing costs, taking out a specific type of loan is one option. Below, we’ll look at what kinds of loans you can use to pay closing costs and how they work.

What Are Closing Costs?

Before diving into loan options, let’s quickly recap what closing costs are so you understand why they may require a separate loan.

Closing costs are fees you pay to finalize or “close” on a mortgage loan and officially buy a house They cover expenses like

• Application fees – Some lenders charge you to apply and process your loan. This fee can range from $0 to $500+ depending on the lender

• Appraisal fee – The lender hires an appraiser to value the home. Appraisals help ensure you aren’t overpaying Expect to pay $300-$600.

• Credit report fee – The lender checks your credit when reviewing your application. Credit report fees range from $10-$100.

• Origination fees – Charges from the lender for underwriting the loan, including loan processing and document preparation. Around 1% of the total loan amount.

• Title fees – Covers title search, title examination and title insurance to protect against claims against the property. Usually 0.5-1% of the home price.

• Recording fees – Paid to the local government to file your ownership records publicly. Generally around $125.

• Transfer taxes – Tax paid to the government for transferring property ownership. Varies significantly by location.

As you can see, closing costs add up quickly. While the seller may cover some fees, the buyer still tends to pay the bulk of costs.

Loan Options to Pay Closing Costs

If you don’t have sufficient cash reserves to cover closing costs, using loan funds is an option. Here are two common ways to borrow money for closing costs:

1. Wrap Closing Costs Into Mortgage

One choice is simply including your closing costs in the mortgage loan amount you borrow. For example:

• Home purchase price: $200,000
• You need to borrow $15,000 in closing costs
• Your loan amount becomes $215,000

By wrapping closing costs into the total borrowed amount, you avoid paying those costs upfront. However, you’ll pay interest on that money over the full loan repayment term. While easier in the short run, it becomes more expensive long term.

Still, if you have excellent credit and qualify for a low mortgage rate, or plan to refinance down the road, this approach may work. Discuss options with your lender.

2. Separate Closing Cost Loan

Rather than rolling fees into the mortgage, you could take out a separate, smaller loan just to cover closing costs specifically. This keeps the mortgage amount lower.

Closing cost loans typically fall into two categories – secured and unsecured loans:

• Secured – A separate loan using your home equity as collateral. Often advertised as a “closing cost assistance program.”

• Unsecured – An unsecured personal loan not tied to home equity. Unsecured loans typically have higher rates but don’t put your home at risk.

Let’s look at how these two loan types for closing costs work:

Secured Closing Cost Loan

• A separate loan with your home as collateral – This allows lower rates but means the lender can foreclose if you default.

• Loan amount covers closing costs – You borrow only what you need for closing instead of lumping costs into mortgage.

• Payments deferred for 6-12 months – You don’t make payments until after closing.

• Loan term of 5-10 years – Once the deferred period ends, you repay the loan over several years.

• Rates from 3-10% – Secured loans have lower rates than unsecured but still higher than a primary mortgage.

Unsecured Closing Cost Loan

• An unsecured personal loan not tied to property – This has higher rates but doesn’t put your home at risk if you default.

• Loan amount up to $35,000 – Borrow only what you need. Lenders may cap loan amounts.

• Terms often 2-7 years – A shorter repayment term but payments start right away.

• Rates from 10-35% – Higher than secured loans but available to wider range of borrowers.

• Fast funding – Some lenders fund unsecured loans in as little as one business day.

An unsecured personal loan typically costs more overall than wrapping into the mortgage, but could still be cheaper than a secured home equity loan depending on your rate. Shop and compare options.

Tips for Getting a Closing Cost Loan

If you decide to get a separate closing cost loan, keep these tips in mind:

• Shop carefully – Compare loan fees, rates and terms across multiple lenders. Look at banks, credit unions, online lenders and more.

• Check your rates – Getting rate quotes doesn’t impact your credit score. Submit a few requests to see potential loan rates.

• Mind the timeline – Loan application to funding can take 1-2 weeks. Account for processing times in your home purchase timeline.

• Review the fine print – Read loan terms closely and ask the lender questions to understand the full costs.

• Compare total costs – Look at interest rates but also origination fees, processing fees and other charges that factor into the total cost.

Using Home Equity

If you already own a home, borrowing against your existing home equity is another option to cover closing costs on a new home purchase. Options include:

• Home equity loan – Fixed-rate loan with set monthly payments and term such as 10 or 15 years.

• Home equity line of credit (HELOC) – Revolving credit line you can draw from as needed. Only pay interest on what you use.

• Cash-out refinance – Refinance your current mortgage for more than what you owe and take cash from the difference.

Be cautious about tapping too much equity and ending up overextended, as it could impact your financial stability.

Weighing the Pros and Cons

Like any financial products, closing cost loan options have both advantages and drawbacks to consider:

Potential pros:

• Allow you to buy when you lack enough savings for closing costs

• May offer better rates and fees than high-cost options like credit cards

• Unsecured loans don’t put your home at risk if you later struggle to repay

Potential cons:

• Adds another monthly loan payment to your expenses

• Causes you to pay more interest over time than if you paid costs upfront

• Could make you feel “house poor” if you overextend your total borrowing

Carefully weigh the pros and cons for your personal situation before moving forward.

Closing Thoughts

While coming up with cash to cover real estate closing costs isn’t always easy, looking at your available financing options makes the process less stressful.

You can wrap closing costs into your primary purchase mortgage, take out a separate secured or unsecured closing cost loan, use existing home equity if you’re already a homeowner, or find another solution that fits your needs.

The key is understanding the features and true long-term costs of any loan before committing, so you make the best choice for your finances. This helps you get into your new home while setting yourself up for financial success.