Whether you are buying a home or refinancing an existing loan, closing costs will be a sizable expense — think thousands of dollars. In some cases, it’s possible to roll those settlement fees into the loan. Here’s when and how you can, and also if you should.
How to roll closing costs into a mortgage
A lender may allow closing costs to be rolled into a mortgage if you have enough borrowing power. Here’s what that means.
Loan-to-value, or LTV, is the amount you finance compared to the home’s appraised value. Say you take out a $300,000 loan on a home with a $400,000 market value. Your loan-to-value is 75%. Here’s the formula:
Loan / value = LTV
300,000 / 400,000 = 0.75
With 20% down, you avoid paying mortgage insurance premiums, and with a 75% LTV, you have 5% that might be rolled into the loan for closing costs.
Different types of mortgage loans have their own guidelines regarding the required loan-to-value (which can go as low as 3%). And each lender will determine your borrowing power based on your creditworthiness, including your debt-to-income ratio.
LTV restrictions are one reason it’s hard to roll closing costs into a purchase loan, especially for first-time home buyers. (There are some workarounds. See “Other ways to reduce closing costs” below.) For a refinance, it’s a different matter. With a refi, you’re likely to have some home equity to apply to your LTV ratio. Some lenders may also offer no-closing-cost refinances.
The closing costs that can’t be rolled into a mortgage
Most closing costs can be rolled into a mortgage, but there is one exception. Mortgages backed by the Department of Veterans Affairs, or VA loans, specify that only the VA funding fee can be rolled into the loan principal. The VA funding fee ranges from 0.5% to 3.3%, according to Veterans United.
Should I pay closing costs or roll them into a mortgage?
Reducing the up-front cash requirements for closing costs is an appealing goal; however, it’s important to remember that you are financing those fees with a long-term loan. That means additional interest you’ll pay over the life of the loan.
Also, rolling your closing costs into your loan will likely mean you’ll pay a higher interest rate.
Other ways to reduce closing costs
There are alternative ways to reduce closing costs. Among them:
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With a growing number of buyers’ markets, listing homeowners are more frequently offering seller concessions. That can include paying a percentage of the closing costs.
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A mortgage provider may offer lender credits — the opposite of discount points. A lender will charge a higher interest rate in exchange for cash applied to closing costs. You’ll want to compare the interest rate to what it would be if you rolled your closing costs into your loan.
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If you are a first-time homebuyer, explore cash assistance programs and grants that can be applied toward your down payment and closing costs.
Pay closing costs up front or roll them into your mortgage FAQs
Do you have to pay closing costs up front?
While paying closing costs up front is generally expected, you may have the opportunity to roll them into your mortgage, apply lender credits, or use first-time homebuyer grants and closing cost assistance.
What not to do before a loan closing?
Anticipating a move to a new home might make you eager to upgrade furniture or prepare for home improvements. Lenders encourage pre-closing borrowers to delay any major purchases or the opening of new credit accounts. You don’t want a change in your credit profile to hijack your loan closing.
What’s the typical closing cost on a $300,000 house?
With closing costs generally estimated at 3% to 6% of the loan amount, a borrower could expect settlement charges of $9,000 to $18,000 on a $300,000 mortgage.