Is It Better to Pay Closing Costs or Roll Into a Mortgage?

Closing costs on mortgages are expensive, with 2-5% of the loan amount being typical. Some home buyers choose to roll their closing costs into the mortgage rather than paying them in cash. But is this a good idea? Learn more below about whether you should roll your closing costs into your loan.

Rolling Your Closing Costs Overview

If you are getting a mortgage for a new home, it is critical to understand the financial aspects of rolling your closing costs into the loan. Rolling those costs into the mortgage means you will pay interest on them over the life of the loan.

For instance, if the closing costs on your new loan are $10,000, and your interest rate is $4, your monthly payment will go up by almost $50 per month. And you will pay approximately $17,000 over the 30-year loan term.

Another option is to slightly increase your interest rate in exchange for a closing credit that eliminates or reduces your closing costs. This is called premium pricing. The lender credits you a percentage of your mortgage amount to lower your closing costs.

For example, say you have a $300,000 loan, and you have a rate of 3.875%. The lender might increase your rate by 0.125% to give you a closing cost credit of $3000. This will cost you about $20 per month, or $7,600 over the life of the loan.

The higher loan balance that covers the closing costs raises the loan-to-value or LTV. This means you have less of a cushion between the loan amount and home value. If you decide to take out a home equity loan later, you will have less equity available. If you have a higher LTV, this also means that your profits will be lower when the home is sold.

FHA and VA Loans

FHA and VA loans have other features and fees that should be considered when thinking about rolling closing costs into the mortgage.

For example, FHA loans mandate that the borrower pay an insurance premium upfront, known as a UFMIP. This fee is usually 1.75% of the mortgage amount, and you can roll it into the loan. However, FHA loans require at least 3.5% down, not including your closing costs. So if you are buying a $100,000 home, you must pay at least $3,500 towards the down payment, in addition to the closing costs.

If you get a VA loan, you need to pay a VA funding fee that you may roll into the loan. The fee is paid to the Department of Veterans Affairs to cover people who default on their loans. The amount of this funding fee depends on your military service area and whether this is your first VA loan.

For instance, 2.15% is the funding fee for regular military members getting their initial VA loan and not making a down payment.

Other Options

If you are getting a new purchase loan, rolling your closing costs into the loan may not be possible. But there are other ways to reduce your out-of-pocket costs. You might lower your down payment to lessen what you pay at closing. But a lower down payment boosts your loan-to-value ratio. If the LTV is over 80%, you probably have to pay for private mortgage insurance (PMI).

Another option is to request a seller’s concession on the closing costs. The seller might be willing to pay for some of your closing fees. This could work if the seller needs to sell the home quickly. Whatever the seller pays, you can put toward the down payment. This lowers the upfront cost of the loan. But remember, sellers do not make these concessions unless they have a good reason to accept a lower profit in exchange for getting the deal closed.

You can roll closing costs into your refinance if the additional costs do not put the loan over your lender’s LTV and DTI requirements. The higher loan amount cannot be more than the top LTV your lender will give you. For instance, if your home is valued at $100,000 and the maximum loan-to-value is 80%, the lender will only give you $80,000. They will not increase that number for your closing costs.

Summary

Understanding your current and future financial goals will let you know whether you should roll your closing costs into your mortgage. The money in your pocket now could help you to pay for home repairs or pay down debt.

In that situation, rolling closing costs into the loan could be correct. If you can afford to pay your closing costs out of pocket, it is usually best to do so; rolling them into the loan or taking a higher interest rate increases your net interest costs for years.

References

Rolling Closing Costs Into Mortgage. Accessed at https://www.valuepenguin.com/mortgages/rolling-closing-costs-into-mortgage

Understanding Mortgage Closing Costs. Accessed at https://www.investopedia.com/mortgage/mortgage-guide/closing-costs/

Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Tips.com. Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.