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Closing costs can be expensive, and rolling those costs into your mortgage may seem like an attractive alternative to paying them out of pocket. However, this isn't a universal solution. The type of loan, loan-to-value ratio (LTV), and debt-to-income ratio (DTI) all play a part in determining if you can roll your closing costs into a mortgage.
Can You Roll Closing Costs Into A New Mortgage?
If your mortgage is for a new purchase, directly rolling your closing costs into the mortgage may not always be possible. However, there are other ways to save on your upfront expenses. You can reduce your down payment to decrease your out-of-pocket expenses at closing. However, keep in mind that a reduced down payment increases the LTV ratio. If your LTV goes above 80%, you'll typically need to pay private mortgage insurance (PMI).
You could also try to negotiate a "seller’s concession," in which the seller of a property will pay for certain fees on the buyer's behalf. Whatever you save on loan fees in this way can be put toward your down payment, reducing the overall upfront expense of the mortgage. However, sellers won't make such concessions unless they're willing to accept a lower net profit in exchange for a better chance at closing the sale.
Rolling closing costs into a refinance is permissible as long as the added costs don't push your total loan over the lender's LTV and DTI thresholds. Additionally, the increased loan amount cannot exceed the maximum loan-to-value ratio your lender is willing to extend. For example, if your home is worth $100,000 and the maximum LTV is 80%, your lender will lend you only $80,000. That number will not be extended to accommodate closing costs.
Should You Roll Closing Costs Into Your Mortgage Balance?
When deciding if you should roll your closing costs into your mortgage, it's important to understand the financial consequences of such a decision. Rolling your closing costs into your mortgage means you are paying interest on the closing costs over the life of the loan. For example, say your closing costs are $10,000 and your mortgage has an interest rate of 4% over a 30-year term. Your monthly mortgage payment would increase by almost $48 per month, and you would pay $17,187 over the term.
Alternatively, your lender may give you the option to increase your mortgage interest rate in exchange for a credit that reduces your closing costs. Known as premium pricing, the lender will credit you a percentage of your loan amount to reduce your out-of-pocket expenses at closing. Let's say you have a $300,000 mortgage and you qualify for a rate of 3.875%. In exchange for an increase in your rate of 0.125%, the lender may give you a credit of 1% or $3,000. The increase will cost just over $21 per month and $7,753 over the life of the loan.
The increased mortgage balance used to cover your closing costs increases the LTV, narrowing the cushion between your loan amount and the value of your home. If you want to take out a home equity line of credit later on, there will be less equity to utilize. A higher LTV also means that your net benefit will be proportionally lower when you sell your home.
Knowing your current and future financial goals will help determine whether rolling your closing costs into your mortgage is the right decision. The extra money in your pocket today could serve an immediate need to pay for repairs or pay off other debts. In such instances, rolling your closing costs into your mortgage may be the right decision. If the money is not readily needed, it may be best to skip paying the higher monthly costs and pay the closing costs upfront.
Rolling Closing Costs Into FHA and VA Loans
FHA and VA loans have some unique features and fees that require additional consideration when deciding if you want to roll your closing costs into the loan. You should discuss all features of the loan program with your lender to make sure you fully understand your obligations as a borrower.
FHA loans require the borrower to pay an upfront mortgage insurance premium (UFMIP). The UFMIP is generally 1.75% of your loan amount, and it can be rolled into the loan amount. There is one caveat: FHA loans require a minimum 3.5% down payment, not counting your closing costs. This means if you're borrowing $100,000, you are required to pay at least $3,500 toward your down payment in addition to your closing costs.
VA loans require the borrower to pay a VA funding fee, which can be financed. This fee goes directly to the Department of Veterans Affairs to help cover losses and keep the loan guarantee program viable for future generations of military homebuyers. The amount of your VA funding fee will depend on your type of service and whether this is the first time you are obtaining a VA loan.
For example, the funding fee is 2.15% of the loan amount for regular servicemembers who are taking out their first VA loan and decide not to make a down payment. There are certain scenarios where a borrower is exempt from paying the VA funding fee, including veterans receiving VA compensation for service-connected disabilities and surviving spouses of veterans who died in service or from service-connected disabilities.