The forecasts for the year 2023 reflects high mortgage rates, climbing home prices and steady inflation. Buying a house is a massive financial undertaking. However, closing costs can be one area where you can save some money if you have the right approach. Before we jump into closing costs being included in a loan, let’s get acquainted with the process of closing.
Addressing Some Prerequisites:
What Are Closing Costs?
Closing costs are additional costs that both the buyer and the seller typically pay to finalize a real estate transaction. They are unavoidable yet negotiable. They make up approximately 3-6% of the loan amount. Most of these costs go to compensate the professionals and third parties involved. These costs don’t include the down payment. Typically, this comprises a variety of expenses. To name a few: homeowners insurance, taxes, real estate agent commissions, and the lender’s fees for servicing the mortgage. They depend on factors such as your state, your lender, and the type of loan you have opted for.
What is The Closing Cost Process?
The Closing Cost process takes approximately 30-45 days to complete. The process starts after you properly audit your finances, fill in the mortgage application, and ends at the closing table. This takes place at the office of your escrow company, title agent, or attorney.
According to the law, your lender must present the Closing Disclosure (CD) 3 days before the day of closing. The CD lays down all the important details of your loan. Further, you can compare this with the loan estimate provided to you to ensure there aren’t any dissimilarities.
Can You Roll Your Closing Costs into a Mortgage?
If you want to find ways around paying closing costs upfront, you definitely can roll it into a mortgage. But, it is essential to note that it is not an ideal choice for everyone. To help yourself evaluate better, read on.
How to Include Closing Costs in a Loan?
Closing costs can be rolled into a loan in several ways:
▶️ Included in the loan amount: Closing costs can be included in the loan amount, bringing the total up and extending the mortgage’s term. This is referred to as financing the closing fees. This is a popular choice for borrowers who lack the funds to pay the costs upfront.
▶️ Given as a separate fee: Closing costs can be paid as a separate fee at closing. This option is typically used by borrowers who have the cash available to pay the costs upfront and want to keep the loan amount as low as possible.
▶️ Paid by the seller: In some cases, the seller may agree to pay a portion of the closing costs as a tactic to attract a buyer. This is known as a seller’s concession and is negotiable as part of the purchase agreement.
▶️ Paid by the lender: Some lenders might offer to pay a portion of the closing costs as an incentive to attract borrowers. This is known as a lender’s credit and may be offered in exchange for a higher interest rate on the loan. In the lending industry, this is also known as a “pricing premium”.
Before making a choice, it’s essential to understand all of the loan’s terms and conditions, including the closing charges. For the purpose of choosing the loan option that best suits your unique needs and circumstances, you should also weigh the costs and advantages of various loan options.
To assist with navigating the loan and closing, consulting a lender or real estate professional is advised.
- 💡Did you know? Including your closing costs in a loan will reduce your upfront costs, but it can raise your loan-to-value (LTV) and debt-to-income (DTI) ratios. Keeping them in check can prove to be instrumental because a big shift in these ratios can ideally, never play in your favor if you are buying or refinancing a house.
What is a Loan-To-Value (LTV) ratio?
The Loan-to-Value ratio is a simple calculation that assesses how much expenditure was required to acquire an asset in comparison to that asset’s value. It also gives an idea of the borrower’s equity in the property, or how much money would be left over after paying off the loan and selling the property.
It’s generally a good idea to plan to put down at least 20% of the home’s cost in order to get accepted for a mortgage; this would result in an LTV of 80% or less. If your LTV is more than 80%, your loan might not be approved or you might need to get mortgage insurance to obtain it.
What is a Debt-To-Income (DTI) ratio?
The Debt-to-Income (DTI) ratio evaluates a person’s monthly debt payments in relation to their monthly gross income. It measures whether a borrower can afford to take on further debt, like a mortgage or vehicle loan, and is stated as a percentage. A borrower with a lower DTI usually has more income available to pay off debt, which lenders view favorably. On the other side, a high DTI indicates that a borrower may find it difficult to make loan payments and may be viewed as a higher risk.
By and large, 43% is the highest DTI ratio a buyer can have to still be approved for a mortgage. A debt-to-income ratio of less than 36% is favored by lenders, with no more than 28% of the debt serving as a mortgage or rent payment.
The Fors and Againsts of Including Your Closing Costs in a Loan:
The biggest argument in the favor of rolling your closing costs into a mortgage is the fact that you are left with more cash in hand and less money spent out of your pocket. Although, you are also paying interest on those costs throughout the life of the loan.
Let’s take an example to understand better:
Assuming that,
The closing costs on your mortgage add up to $6,000 and your interest rate is locked at 2.5% on a 30-year term.
Your monthly mortgage will increase
If you add your closing costs to your loan, your Loan-To-Value ratio also goes up. As a consequence, the equity in your home reduces. This means you get less profit when you sell your house because you’d have a bigger charge to pay off after the sale.
Closing Disclosures (CD) and Loan Estimates (LE):
After your loan application is reviewed, you are sent a Loan Estimate (a good-faith estimate) as required by the Consumer Financial Protection Bureau. The LE is an estimation of the approximate costs you can anticipate paying if you finance your home with that specific lender.
As required by law, the Closing Disclosure must be provided to you three days before closing. It shall include an itemized list of the loan fees that you’ll be paying. Comparing the LE and CD should be on top of your list as soon as you have them in your possession. Common errors can occur which can cost you super heavily.
Strategies to Reduce Closing Costs:
You may encounter hard times trying to find your way around closing costs, but no matter. There are a few strategies you can deploy that may prove to be beneficial:
- Ask your home seller to help with your closing costs. They could pay for a portion, or all of the costs if you negotiate that into your contract as a seller’s concession.
- You can opt for mortgages with no closing costs. You will have to pay a higher interest rate in exchange for help from your lender.
- Ask your friends or family to chime in. Various loan types allow you to use gift money for closing, for which you’d want to keep your loan officer posted.
- Applying for grants and personal loans. You can check if you qualify for any concessions for the down payment and closing cost assistance programs. They are local and their eligibility varies.
Make sure to have a word with your lender about which closing costs can be financed and which ones don’t fit.
The Finish Line: What Fits You Best?
It is important to note that while you definitely can include your closing costs in a mortgage, it will cost you more in the long run.
On the other hand, you should also consider this aspect if you are spending a large portion of your savings on the down payment. If you are short on cash, rolling closing costs in loans might be a catch! Although we advise you open-mindedly assess your circumstances and keep your options open. Shopping around is never a bad idea.
Also Read
» FHA Gift Funds: Read to know more.
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Frequently Asked Questions
Is it a good idea to finance your closing costs?
It depends on the specific financial goals of the borrower. On one hand, It can facilitate the homebuyer to make the purchase without having to pay a hefty amount of money upfront. On the other hand, It results in higher monthly payments and adds up to be more expensive in the longer run. It is essential to consider interest rates, loan terms, and the overall financial situation before making a decision.
Are closing costs tax deductible?
Closing costs are generally not tax deductible in the year in which they were paid. However, some of the fees included in closing costs can be included in the tax basis of a property and can be deductible when the property is sold. This includes items such as points paid to lower the interest rate on a mortgage, property taxes, and certain prepaid interest charges. It's important to consult with a tax professional to determine which closing costs may be deductible and to understand the tax implications of a home purchase.
Which closing costs can be financed?
Typically, most closing costs can be financed as part of a loan. This may include:
1. Loan origination fee
2. Appraisal fee
3. Credit report fee
4.Underwriting fee
5.Title search and insurance fee
6. Survey fee
7. Recording fees
8. Transfer taxes
9. Prepaid interest charges
10. Property taxes
11. Homeowner’s insurance premiums
12. Discount points
Can closing costs be included in VA Loan/FHA Loan?
Yes, closing costs can be included in a VA/FHA loan. A percentage of the borrower's closing expenses may be covered by the seller, the lender, or a combination of both under the VA and FHA. These loan programs could also include clauses that allow borrowers to finance their closing fees into the loan sum. While closing costs can be financed throughout the course of a VA/FHA loan, borrowers should be aware of the additional interest fees that come with doing so.
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