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Can you include closing costs in your mortgage?

Can you include closing costs in your mortgage?

Buying a home is an exciting milestone, but it also comes with a lot of fees called “closing costs.” These costs, which can range from 2-5% of the purchase price, cover things like appraisals, title insurance, and loan fees.

If you’re like most buyers, coming up with thousands of dollars in cash for closing costs can be a challenge.

The good news is you may be able to include closing costs in your mortgage. But is that the best idea for your situation? 

Let’s take a closer look.

How Much Are Closing Costs on a House?

Closing costs on a house typically range from 2% to 5% of the home’s purchase price. These costs include fees for services such as property appraisal, title search, title insurance, loan origination, and attorney fees. Other expenses may include inspection fees, escrow fees, and prepaid property taxes and insurance.

Here are some of the common closing costs you can expect:

  • Loan origination fee – This pays for the lender’s work in processing your loan application and underwriting your mortgage. It ranges from 1-2% of the loan amount.
  • Appraisal fee – An appraiser will visit the home and determine its market value, to ensure the price you’re paying is appropriate. This usually costs $300-$500.
  • Credit report fee – The lender will pull your credit report to evaluate your creditworthiness. This is generally $25-$50 per report.
  • Title insurance fee – This insures the lender against defects in the legal title, so you don’t have claims against the property after closing. Expect to pay 0.5-1% of the purchase price.
  • Recording fees – The county charges a fee to officially record the deed and mortgage documents. This is generally under $100.
  • Transfer taxes – State and local governments charge a tax whenever a property changes hands. It’s usually a percentage of the purchase price (e.g. 1-2%).
  • Prepaid interest – You pay interest on your mortgage loan for the period between closing and your first payment. So if you close June 1 and your first payment is July 1, you’d prepay interest for June.

As you can see, closing costs add up quickly. In many cases, you’ll need to bring $5,000-$10,000 (or more) to closing to cover these fees.

Is Cash to Close the Same as Closing Costs?

  • Cash to close and closing costs are related but not exactly the same thing. Cash to close refers to the total amount of money a buyer needs to bring to the closing table, which includes the down payment, closing costs, and any other fees. 
  • Closing costs, on the other hand, specifically refer to the expenses associated with finalizing a real estate transaction, such as loan origination fees, title insurance, and appraisal fees. While cash to close includes closing costs, it also includes the down payment and other expenses.

Should You Roll Closing Costs Into Your Mortgage?

If you don’t have enough cash on hand, rolling closing costs into your mortgage can seem like an attractive option. Essentially, this means you borrow extra money to cover the fees, and then pay it back over time through your regular monthly mortgage payment.

While it solves the problem of coming up with cash, there are tradeoffs to consider:

  • You’ll pay interest on the closing costs over the life of the loan. For example, an extra $5,000 at 4% over 30 years means you pay an extra $2,668 in interest.
  • Your monthly mortgage payment will be higher because you’re borrowing more money. How much higher depends on the amount rolled in and your loan term.
  • You may get a higher mortgage rate. Lenders often give better rates to borrowers who bring their own cash to close.
  • It could affect your loan-to-value ratio and down payment requirements. Especially on FHA and VA loans with minimum down payments.

On the plus side, rolling in costs can help you buy now if you need more time to save up a cash down payment. And on very low rate loans, the extra interest may amount to less than you’d expect.

How Can You Reduce Closing Costs?

Rather than rolling them into your loan, it’s always better to pay closing costs upfront if possible. Here are some tips:

  • Shop lenders and negotiate – Compare quotes from different lenders and let them compete for your business. Ask if they’ll waive or reduce any fees.
  • See if the seller will pay – In competitive markets, it’s common for sellers to pay 3-6% of purchase price in closing costs.
  • Use gift funds strategically – If you receive a gift from family, you could use it for your down payment and pay closing costs yourself.
  • See if you qualify for lender credits – Some programs come with a lender credit, reducing your out of pocket costs.
  • Lower third party fees – Research title fees, shop home insurance, and see if you can bring down appraisal costs.

Should You Include Closing Costs in Your Mortgage?

At the end of the day, look at your specific situation:

  • How much cash can you come up with? Paying costs upfront is ideal if possible.
  • What rate are you getting? On a super low rate, the extra interest may be negligible.
  • How long is your loan term? Interest adds up more over 30 years than 15 years.
  • What programs are you eligible for? FHA and VA loans come with lower costs than conventional loans.

Carefully weigh the tradeoffs based on your mortgage details. While rolling in costs can help in a pinch, try to pay them upfront or offset them if you can. This will save money over the long run.

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