Financing closing costs might save you having to come up with a lot of cash, but is it worthwhile doing? Here we shall discuss closing costs and the pros and cons of financing them in full or in part.
Closing costs include items such as loan-origination fees (0.5% – 1.5% of loan amount,) credit check fees, title fees, mortgage insurance (1 year in advance,) points for mortgage interest discounts and more. When combined, mortgage fees can total around 2% – 4% of the purchase price of the property. So, if you buy a home at $200,000, the closing fee can be as high as $8,000.
Financing Closing Costs in the Mortgage
If you roll your closing costs into your mortgage loan you will be paying a lot more than $8,000 over the term of the loan – particularly if that is 30 years. You will be paying closing fees for 30 years, and also interest on them.
$8,000 in costs, amortized over 30 years at 4.0% interest, would involve an extra $38.19 on your monthly repayment figure. Work that out over the term and financing closing costs of $8,000 would cost you a total of $13,748.40, or $5,748.40 extra.
Partially Financing Closing Costs.
An option is to ask the seller to help out with closing costs. This is not uncommon when real estate markets are in a downturn, and it is a buyer’s market. If the seller is keen to sell, then they may be open to doing this just to get their property sold. However, your lender might restrict the amount that the seller is permitted to contribute in this way. FHA insured mortgages, for example, tend to have such restrictions.
LTV and Closing Costs
As you now have realized, arranging for your closing costs to be included in your mortgage loan is not so easy. It is not a standard option, such as choosing a fixed interest rate or an adjustable rate. You must meet certain criteria, an important one of which is you persuading the lender to give you a mortgage loan greater than the value of the property. In other words for them to offer an LTV (loan to value) of greater than 1.0.
Rolling Closing Costs into Refinance or Reverse Mortgage Loans
Because this is very abnormal, it is more common for closing costs to be financed when refinancing a mortgage or arranging a reverse mortgage, where the total finance can involve a higher proportion of your equity than you are receiving in cash.
For example, let’s say you have $150,000 equity in a $200,000 home, and are seeking equity release of $60,000 for a home improvement. Your closing costs might be $1,000. You can add this to your loan and repay $61,000. The equity still in your home warrants this.
Financing closing costs is not common for first mortgages. It is unusual for the buyer to be able to add these costs to the loan due to the effect on the LTV. It more common to finance closing costs in this fashion with refinance agreements since there tends to be sufficient equity in the home to offer the lender an appropriate level of security.
However you do it, rolling your closing costs into a home loan will cost you extra. This cash will also be unavailable for you to invest, thus compounding the potential cost. Unless you intend to use the cash you save initially to invest in higher yield investments, it is best to consider your own financial situation. If you are unable to pay your closing costs, then you are advised either to seek a lower priced home or wait a while longer until you have more funds available. Financing closing costs is not always the best solution.