Reader question: “I can cover my down payment expense when buying a house. But the closing costs are going to be a bit of a stretch for me. The monthly payments are not an issue, because I’ve had steady income and employment for years. It’s the upfront out-of-pocket expense that’s a challenge. Can I roll my closing costs into the home loan, instead of paying them all up front?”
You might not be able to roll those costs into your mortgage, technically speaking. But the lender could be willing to reduce your out-of-pocket fees, if you agree to take on a higher rate.
There is a clear tradeoff here. You are paying less money up front / out of pocket, but you will end up paying more money over the life of the loan due to the higher rate. Less up-front cost, with more interest paid over the long run. So technically, this is a home loan that will cover your closing costs.
Reduce Closing Costs by Taking a Higher Rate
But note the distinction here: You are not truly rolling the fees into your mortgage. You are paying more interest over the repayment term of the loan in exchange for waived or reduced closing costs.
During the housing boom, many lenders would allow borrowers to roll in the closing costs. There were also no-down-payment and no-documentation (no doc) home loans back then. As a borrower, you could secure a mortgage with nothing out of pocket and very little documentation. But much has changed since then. Today, no-cost financing is harder to come by. But you still have options.
Three Ways to Pay
Generally speaking, there are three ways to cover your closing costs:
- You could pay them in cash when you close on the loan (the most common strategy).
- You could ask the lender to waive some of the fees, in exchange for taking a higher rate.
- You could add your closing charges onto your loan balance (if refinancing).
Depending on the type of market you are in, you could also ask the seller for a contribution or “concession” to cover some of your costs. For instance, you could make a strong offer and then ask the seller to cover part of your fees. Sellers can contribute up to 6% of the purchase price for FHA, and 3% on most conventional loans. This can be applied to the buyer’s closing costs. But we’re getting off track here.
In a typical home-buying scenario, you would have to choose option #1 or #2 above. You would either pay the fees up front, or ask the lender to waive some of them in exchange for a higher mortgage rate. If your primary goal is to reduce your closing costs, then you might consider the second option — taking on a higher interest rate. As you can see below, there are pros and cons to both of these strategies:
Paying Cash Up Front at Closing
- Pros — You’ll be able to secure a lower interest rate, which could save you a considerable amount of money over time. This is the ideal strategy in many cases, especially if you plan to keep the loan for a long period of time.
- Cons — You have to deplete your savings to cover the upfront cost. For some people, this means losing their all-important emergency fund.
Taking a Higher Rate for Reduced Closing Costs
- Pros — You won’t have to spend as much money out of pocket. You’ll be able to keep some cash in the bank for emergencies.
- Cons — You’ll probably end up with a higher mortgage rate in exchange for the waived and/or reduced fees. This could significantly increase your borrowing costs over time, especially if you keep the loan for many years.
Some banks, credit unions and lenders offer “zero-closing-cost mortgages” for select borrowers. This is the strategy mentioned above, wherein the borrower agrees to a higher mortgage rate in order to reduce (or completely eliminate) the out-of-pocket fees. The “markup” is typically 25 basis points, or 0.25%, but it can vary from one lender to the next.
For example, at the time of publication, Teachers Federal Credit Union offered a 30-year fixed-rate mortgage loan with no closing costs. The credit union even paid the third-party fees, such as the appraisal and title search fees. This is just one example of many. With many of these products, the borrower will have to agree to a “rate adjustment” that brings higher interest charges over the life of the loan.
For some borrowers, this kind of trade-off is acceptable. They are willing to take on a slightly higher monthly payment in order to reduce, or even eliminate, their up-front closing costs. Just keep in mind not all lenders offer this kind of strategy. So if it’s important to you, you’ll have to shop around and ask question up front.
Another common scenario is when the lender waives their own fees, but the borrower still has to pay for certain third-party fees such as the home appraisal, title search, and credit check. These are sometimes marketed as “zero-cost” loans, when in reality there are still some fees to be paid at or before closing.
Read: How much will it cost me to close?
The Good Faith Estimate
When you apply for a mortgage loan, the lender is required by law to provide you with a Good Faith Estimate or GFE. You’ll probably receive this document within a day or two of submitting your application. Among other things, it gives you an estimate of how much your closing costs will be.
The second page of the GFE shows how the lender arrived at their estimate. It provides a line-item breakdown of the different closing costs associated with your mortgage loan. Here’s what that section looks like:
The exact charges may be slightly higher or lower than the Good Faith Estimate (hence the term “estimate”), but at least you’ll see which costs you have to pay when you close.
If the lender offers to waive or reduce some of their closing costs, but those fees show up on the GFE document, you should be asking some questions.
Disclaimers and notes: This article answers two common questions asked by home buyers and homeowners: How can I reduce my closing costs, and can I roll them into my loan? We strive to be as thorough as possible when answering such questions. Still, there may be additional strategies, products or options that were not covered above. So we encourage you to conduct additional research beyond this website. This article has been provided for a general audience and contains generic scenarios that may not apply to all borrowers. This information should not be viewed as financial advice.
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