Curve

Roll closing costs into your mortgage, or avoid them completely

Craig Berry
The Mortgage Reports contributor

You don’t always have to pay closing costs on your own dime

Whether you’re buying a new home or refinancing an existing mortgage, there are usually closing costs associated with obtaining a home loan.

If you are trying to limit your out-of-pocket funds, the good news is that you have other options.

One option is to roll closing costs into your mortgage. That way, you pay them off over the loan period rather than upfront.

Sound appealing? Here’s what you need to know.

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Can you roll closing costs into your mortgage? 

If you are purchasing a home, you likely won’t be able to roll the closing costs back into your mortgage. This option is typically only open to those refinancing an existing home loan.

When buying a home, you usually have four options for covering the closing costs:

  1. Pay all of the closing costs on your own
  2. Negotiate seller concessions where the seller pays for some or all of the costs
  3. “Buy up” the interest rate so that the lender pays for some or all of the costs
  4. In some rare cases, you may be able to finance closing costs when buying with a USDA loan.

There are also ways to cover closing costs with gift money (from a relative or friend) or a grant from a public agency, if you’re unable to pay them out of pocket.

Financing closing costs is easier for a refinance

The rules for rolling closing back into your mortgage are different if you are refinancing.

As long as rolling the costs back into your mortgage doesn’t impact your debt-to-income (DTI) or loan-to-value (LTV) ratios too much, you may be able to roll closing costs back into your new loan.

  • As an example, let’s say your new loan amount is $200,000, excluding closing costs
  • If your home is valued at $250,000, your LTV is 80%. (200,000 / 250,000 = 0.80)
  • If your maximum approval is 80% LTV, or you’re just wanting to stay at or below the 80% mark in order to avoid paying mortgage insurance, you may not be able to roll the closing costs back into your loan

But if your loan-to-value ratio is low enough (meaning you have more equity in the home at the time your refinance), taking on a small extra loan amount might not make too much of a difference.

What does it mean to roll closing costs back into your loan?

Rolling your closing costs back into the mortgage means you are adding the costs to your new mortgage. This is also known as financing your closing costs.

Financing your closing costs does not mean that you avoid paying them entirely.

It simply means that you don’t have to bring thousands of dollars to the closing table.

If you don’t want to empty your savings account at the closing table — and if your rate is low enough that you’ll still save — financing your closing costs over the term of your mortgage might be a helpful way to save money.

What are the pros and cons of rolling closing costs into your mortgage? 

When you roll closing costs into your mortgage, you have less out-of-pocket funds and more cash on hand.

However, you are also paying interest on those costs over the life of the loan.

For example, let’s assume:

  • The total closing costs on your new mortgage is $5,000
  • You have an interest rate of 4.5% on a 30-year term

Then:

  • Your monthly mortgage payment would increase by $25 per month
  • And you would pay an extra $9,000 over the 30-year term

In addition, by adding the closing costs to your new mortgage balance you are increasing the loan-to-value. By increasing the LTV, you are reducing the amount of equity in your home.

Less equity means less profit when you go to sell your home. You would also have less equity if you wanted to take out any type of home equity loan.

What lenders will let you roll closing costs into the mortgage? 

Most lenders will allow you to roll closing costs into your mortgage when refinancing.

Generally, it isn’t a question of which lender that may allow you to roll closing costs into the mortgage. It’s more so about the type of loan you’re getting — purchase or refinance.

When you buy a home, you typically don’t have an option to finance the closing costs. Closing costs must be paid by the buyer or the seller (as a seller concession).

But with a refinance, many lenders will allow you to roll the closing costs into the loan provided you still meet lending criteria (DTI and LTV) after doing so.

Is rolling closing costs into your loan the same thing as a “no-closing-cost” mortgage?

Rolling closing costs into your mortgage is usually not the same thing as a “no-closing-cost” mortgage.

Generally, when lenders advertise “no closing cost” or “zero closing cost” mortgages they are referring to the process of trading a slightly higher interest rate in return for a “lender credit.”

A lender credit means the mortgage company will cover part or all of your closing costs.

With these mortgages, the lender will front many of the initial closing costs and fees, while charging a slightly higher interest rate over the duration of the loan.

>> Related: Get a no-closing-cost mortgage and a low rate, too

The downside is you’ll pay a larger monthly payment over the long haul. And, you’re likely to pay significantly more in interest overall.

However, the idea is that you don’t have to come up with as much cash up front. This can be helpful when you are also having to come up with a large down payment.

Does rolling closing costs into your mortgage reduce the amount of interest you can deduct? 

Typically, no. The amount of interest you can deduct on your taxes isn’t impacted by rolling the closing costs into your mortgage.

Choosing a slightly higher interest rate in lieu of closing costs, however, can give you a bigger interest deduction. This is because you’ll be paying a slighter higher rate, which means paying more interest.

Be sure to consult a tax professional for your specific situation on what you can or can’t deduct.

>> Related: Complete guide to mortgage tax deductions

How else can I avoid paying closing costs?

As we mentioned above, you can usually only roll closing costs into your mortgage when you refinance. But there are other ways to reduce your closing costs when buying a home.

The first is asking your mortgage lender to waive some or all of your closing fees. But this may be a long shot if the lender doesn’t have an incentive to do so, such as the ability to charge you a higher interest rate.

Or, you can roll closing costs into a USDA loan if your appraised value is higher than the purchase price. More on that here.

But a more common solution may be to ask the seller to cover some or all of the closing costs. This is known as a seller concession.

A seller concession works like this:

  • Determine the amount of closing costs you’d like the seller to pay
  • Assuming the seller agrees, that amount is added to the purchase price
  • You get a mortgage for the new purchase price which now includes some or all closing costs
  • The seller kicks back that extra amount to cover your closing costs
  • This is a way to roll the closing cost expenses into your loan, which ordinarily isn’t allowed unless you’re refinancing a mortgage

>> Related: Getting a seller to pay your closing costs

There are many ways this may look depending on what is negotiated between the buyer and seller.

Here’s one example of how a seller concession might look:

  • Original purchase price: $200,000
  • Closing costs: $5,000
  • New purchase price: $205,000
  • Seller concessions for closing costs: $5,000
  • Your out-of-pocket closing costs: $0

Keep in mind that, in a buyer’s market, the seller may offer concessions even without a home price hike. It’s always good to ask for that option first.

Whether you roll your closing costs back into your mortgage or not, there’s almost always closing costs associated with obtaining a home loan.

But rolling closing costs into a mortgage can be a great way to save on out-of-pocket cash.

Find a low- or no-closing-cost loan

If you’re refinancing, you should have options for rolling closing costs into your loan. Simply compare offers from a few different lenders and see which one suits your needs.

If you’re buying a home, you likely won’t be able to finance your closing costs.

But look into other options, like a seller concession or lender-paid closing costs with a higher interest rate. These could help you if you can’t make up the out-of-pocket finds.

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