Closing costs can be as much as 5% of your loan amount. That’s a lot of money and if you don’t have it, you may wonder if you can roll the costs into your loan.
The answer is a divided one. If you are purchasing a home, you won’t be able to roll your closing costs into your loan. Don’t worry, though, we provide you with other solutions if you are buying a home. If you are refinancing your loan, you may be able to wrap those costs into it if everything falls into place.
Wrapping Your Closing Costs Into a Refinance
First, you should understand the consequences of rolling your closing costs into your loan. Sure, it will save you money upfront. You won’t have to come up with thousands of dollars. But if you look at what those closing costs turn into over the life of the loan, you may want to rethink your choice.
If you borrow the money to cover your closing costs, you pay interest on that money. Let’s say you took out a loan for $200,000, but wanted to wrap your $10,000 of closing costs into it. You just increased your loan to $210,000. You now pay interest on $210,000. That $10,000 in closing costs just became much more as you take 30 years to pay it off.
If you still want to do it, you’ll need to make sure you have enough equity in the home. Each loan program has a maximum LTV that they’ll allow. If your outstanding principal balance brings you below that LTV and adding the closing costs to the balance still keeps you below it, you may be able to wrap the costs into your loan.
Each lender has their own requirements regarding this. Some require a certain credit score and/or debt ratio in order to take the risk of increasing your loan amount just to cover the closing costs.
An Option for Refinances and Closing Costs
If you don’t want to roll your closing costs into your refinance, you do have one option. You can ask the lender for a no closing cost loan. This means the lender covers your closing costs for you. Of course, they won’t do this out of the goodness of their own heart. In exchange for the closing cost coverage, the lender will increase your interest rate, usually about ½ of a point.
While you might balk at the idea of paying a higher interest rate, it may make sense if you don’t plan to be in the home for the long term. If you know you’ll move in the next five years, paying ½ point higher in interest will be much less expensive than paying 5% of your loan amount in closing costs.
An Option for Purchases and Closing Costs
Now what about those that want to purchase a home? They can’t roll their costs into their loan. What they can do, though, get help with their closing costs. Help can come from the seller, a family member, or even their employer.
If the money comes from the seller, it’s called a seller concession. You must negotiate this with the seller at the onset of the purchase contract. It must be included in the contract and agreed upon by both parties. Each loan program has a maximum amount that sellers can contribute before they consider it an inducement to purchase. It’s usually large enough to cover some or all of the closing costs, though.
If the money comes from a family member or employer, there must be a gift letter. This letter must state the exact amount the donor gives you as well as the reason for it (the reason should be to purchase the home). The donor should then state that the money is not a loan and sign it.
You and the donor will then have to provide proof of the transfer of funds. The lender may also want proof of where the donor obtained the funds. For example, if they sold stocks to give youth he funds, they would need to provide proof of the sale and the transfer of funds to your account. This helps keep a paper trail and ensures that you don’t have an outstanding loan somewhere.
Paying closing costs may seem impossible, but there are ways to get it done including wrapping them into your loan amount if you are refinancing. Talk to your lender about your options in regards to closing costs to make sure you can afford your loan.