Can you roll closing costs into the mortgage?

by Tom Tousignant

in Blog, Home Buying, Mortgages

I often get asked by home buyers and owners who are refinancing if they can ‘roll the closing costs into the mortgage’.  It is really two different issues, depending on if you are buying a house, or refinancing your current mortgage.  In this post, I’ll talk through the house buying strategy.

Closing Costs when buying a House

While the mainstream media is quick to call all closing costs, ‘Junk Fees’, they forget that some, or most, closing costs are legitimate fees – people actually go to work each day to appraise houses, set up tax service accounts, verify houses aren’t in flood plains, process loans, underwrite loans, and prepare documents for loan packages. (not to say, however, that I have seen some legimate junk fees on closing estimates before – but that’s for another post to discuss).

 So, how should you, as a house buyer, deal with closing costs?  Can you roll them into the loan?  Short answer – not really. however, there are three ways to pay closing costs – you can pay them, the seller can pay them, or the lender can pay them – or any combination of the three.

Option 1 – you pay the closing costs:

With this option, in addition to your downpayment, you will pay the normal lender fees, attorney  / escrow fees, appraisal, credit report and title insurance.  You will likely have an Origination Fee also, which is usually a percentage of the loan amount, to pay the loan officer and his/her associated costs – office rent, telecom, utilities, taxes, etc.  Some lenders will smoothly tell you they don’t charge an origination fee, and therefore are saving you money.  They are really either 1) working for free and rent free (Unlikely), or 2), they are combining option one with option two and not telling you the whole story.

Option Two – Lender pays the closing costs:

Lenders will offer a ‘Par’ rate to loan officers – this is the rate at which they are willing to lend money, and it changes every day, sometimes many times during a day.  In cases where the borower doesn’t want ot, or can’t pay the closing costs, lenders will offer the loan officer an option of ‘premium pricing’.  With premium pricing, a lender refunds a percentage of the loan amount back to the loan officer in exchange for a higher rate.  As an example, let’s say today ‘Par’ rate is 5.0%.  If you agree to pay 5.25% to the lender, they will rebate 1.0% of the loan amount back to the loan officer at closing, and a rate or 5.5% may result in a rebate of 2%. The loan officer can then use that money for the same things he would have used the origination fee for, or he can use that money to pay all or some of the customer’s closing costs. So, if someone tells you he is not ‘charging you an origination fee’, ask him is he working for free or is the lender rebating money back to him. 

The tradeoff with lender paid closing costs is that you trade lower closing costs for a higher interest rate, or higher monthly payments.  A good loan officer should be able to show you the exact total costs of your choices – how much will you spend in interest and closing costs over the life of the loan.  If you have a choice, choose the option with the lowest total cost – not just the lowest closing cost or the lowest interest rate.  If you don’t have the option of paying all the closing costs yourselfd, but still need the lower payment froma lower interest rate, you can always look to options three:

Option Three – Seller pays closing costs:

When the seller looks at an offer from a potentail buyer, the real calculation to them is their net equity – that is, how much will the closing agent hand themy accept at closing.  So, from the seller’s perspective, it really doesn’t matter if they get an offer, for example of $250,000 or $245,000 in which they pay $5,000 in closing costs for the buyer. 

As a buyer, this is the best way to not pay closing costs from your cash on hand, with the smallest impact to your monthly payment.  If you increase your loan amount by $5,000 using this strategy, your monthly payment would go up by $25-$30 per month in most cases.  Compare this to paying 0.25% to 0.5% higher in interest or using several thousand dollars of your cash, and often times this is a great way to ‘roll the closing costs into your loan amount’.

Comments on this entry are closed.

Previous post:

Next post: