I hear new real estate investors and homebuyers ask all the time: “Can you roll closing costs into a mortgage?”
The short answer is yes for refinance loans, no for purchase loans. But it’s not always possible even for refinances, and even when it is, that doesn’t mean you should roll closing costs into your loan.
As you explore the idea of including closing costs in your next loan, keep the following points in mind, and always be careful not to overleverage yourself.
LTV and Refinance vs. Purchase Mortgages
When you borrow a mortgage, the lender agrees to lend you a certain percentage of the property’s value, referred to as the loan-to-value ratio or LTV. For example, say you want to buy a property for $200,000, and the lender agrees to an LTV of 90%. They would then lend you $180,000 or 90% of the purchase price.
For purchase loans, you need to come up with cash for a down payment to cover the remaining balance, plus the closing costs. But in refinance loans, you might already have enough equity in the property to roll the closing costs into the mortgage.
Say you own a property worth $200,000, and you only owe $100,000 on it. The lender agrees to an LTV of 90%, or a loan of $180,000, of which $100,000 goes to paying off your existing loan, and the remaining $80,000 goes to your cash out and closing costs.
The higher the LTV, the greater the risk for the lender. Higher LTV loans tend to come with higher interest rates and higher closing costs. When your LTV ratio goes beyond that percentage, lenders may require you to purchase private mortgage insurance (more on that shortly).
Can You Roll Closing Costs into a Mortgage?
Rolling your closing costs in a mortgage means adding the costs to your new mortgage loan amount. This helps to limit out-of-pocket money and leaves more cash at your disposal. The rolling closing costs option is only available to those refinancing an existing home loan. If you purchase a home in cash, you cannot roll closing costs into a mortgage.
Provided rolling the closing costs into your mortgage does not affect your loan-to-value (LTV) and debt-to-income ratio (DTI) heavily, you can consider moving these costs back into your new loan.
You will be paying interest on your closing costs until your mortgage matures. For instance, let’s take:
- The sum closing costs on your new mortgage is $10,000
- You have a 5% interest rate on a 30-year term.
- Your monthly mortgage payment would elevate by $50 per month.
- And you would pay an extra $15,000 in interest over the 30-year term.
By rolling the closing costs to your new mortgage balance, you are elevating the LTV. The elevation in loan-to-value decreases equity in your home, which translates to less profit when you decide to sell your property. The amount of interest you can deduct on your taxes is not reduced by rolling closing costs into a mortgage.
Negotiate a Seller Concession Instead
Everything in life is negotiable. As you negotiate a better real estate deal, consider negotiating for a seller concession to cover your closing costs.
They agree to chip in a certain amount at the settlement table toward your costs, out of their proceeds. Often, this proves better than a lower purchase price, since it means coming up with far less cash at the table. Rather than asking for a lower price, and therefore a lower total loan amount, you can potentially eliminate your closing costs entirely.
Or Negotiate a Seller-Held Second Mortgage
Another way to reduce your cash needed at settlement is to negotiate a seller-held second mortgage to cover some or all of your down payment. It’s one of the many ways you can minimize your down payment and buy with less cash.
Say you put a property under contract for $200,000, with a $180,000 loan (90% LTV). You negotiate with the seller to lend you a $15,000 seller-held second mortgage. Now you only have to come up with $5,000 as a down payment!
The BRRRR Method
There’s an exception to every rule. If you want to roll closing costs into a mortgage, you can do so as a real estate investor through the BRRRR method.
It stands for buy, renovate, rent, refinance, repeat, and it works like flipping a house but instead of selling it, you keep it as a rental property. After renovating a fixer-upper, you refinance it for a long-term rental property mortgage. When you do so, the loan amount is based on the after-repair value (ARV), not the initial price you paid.
So, you can take advantage of all that forced equity to pull your initial down payment and closing costs back out when you refinance. If, that is, your renovations created enough equity in the property to justify it. And if the property’s rent justifies taking out such a large mortgage — the last thing you want is negative cash flow! (Run the numbers in our free rental property ROI calculator to ensure strong cash flow.)
How Much Do Closing Costs Typically, Well, Cost?
Usually, real estate buyers incur closing costs ranging from 2-5% of the purchase price of the property in closing fees. For instance, for a purchase price of $200,000, you can expect between $4,000 and $10,000 in closing costs.
The lender will provide you with an estimate of closing costs for your loan, which will constitute your home’s closing costs in the first three business days of submitting your loan application. A legal requirement, this disclosure is known as a Good Faith Estimate or GFE.
Even so, it remains exactly that: an estimate. Many of the fees listed are prone to alteration. If they remain unchanged, you may be issued with an improved loan approximation. This will ensure there are no uncertainties throughout the process. Be sure to ask your lender about if they can include closing costs in a loan.
No more than three business days before your closing, the lender is supposed to provide you with a closing disclosure statement. The statement displays all closing fees. You should read through the statement to your loan and reach out to your lender for an explanation for what and why each item on your closing costs is necessary. There are restrictions on the amount and figures at which fees can increase from the loan approximation to the closing disclosures. These help prevent surprises on closing day, so check the settlement statement carefully before showing up to the table.
(article continues below)
What Do Closing Costs Include?
Both buyers and sellers incur different closing costs – it costs money both to enter and to exit real estate ownership.
Just as you can negotiate real estate deals, you can often negotiate closing costs with lenders. That goes for both “points” and “junk fees.” A point is equal to one percent of the loan amount, and is charged as a sales commission. Typical homeowner mortgages charge 0-1 points, while investment property mortgages often charge 1-3 points. Junk fees are flat fees however, charged as a means of propping up the lender’s profits. They come with names like “administrative fee” and “processing fee” and “appraisal review fee” and “we’re-making-up-whatever-legitimate-sounding-fees-we-can” fee.
While by no means an exclusive list, common closing costs include the following:
- Appraisal: it is remitted to the appraisal company to evaluate the market value of your home.
- Application fee: finances the lender’s charge when processing your application. Cost is incurred to review your credit report. This fee is negotiable, and not all lenders charge for this.
- Prepaid interest: lenders need you to pay the interest that accumulates on the mortgage between the settlement date and the first monthly payment due date. It differs depending on your loan size.
- Attorney fee: these charges are for an attorney to confirm the closing document on your behalf and your lender. It is not mandatory in all states.
- Title search fee: this is incurred to verify that the person selling the house, legally owns it. This can be a tiresome process if the real estate records are not digitized. The estimation for this is about $200 but differs according to states.
- Lenders title insurance: lenders will need a loan policy plan to shield them if there is a problem in the title search process. Someone may claim ownership of the home after it’s sold. The policy is valid until the loan is cleared.
- Owners title insurance: you can buy title insurance to shield yourself if a claim is made on your home after closing. Estimated costs for this vary between 0.5% to 1%.
- Closing/settlement fee: it is remitted to the company witnessing the closing as an independent party in your home buying.
- Home inspection: this covers for home repairs that may be necessary before closing.
- Mortgage insurance application fee: when you deposit 20%, you may have to incur private mortgage insurance (more on that shortly).
Introduction to Private Mortgage Insurance (PMI)
For homeowner mortgages such as Fannie Mae and Freddie Mac loans, you’ll have to pay extra each month for PMI if you borrow more than 80% LTV.
The higher the loan-to-value ratio, the greater the risk profile of the mortgage for the lender. This kind of insurance protects the lender against your default – it doesn’t protect you.
The private mortgage insurance fastens the process for some individuals to become homeowners. If you commit to meet between 5% to 19.99% of the property’s cost, PMI gives you a guarantee of accessing financing. The policy has additional monthly charges. You must pay your PMI until you have accrued satisfying equity in the home that the lender no longer sees them as high-risk.
The costs of PMI insurance range between 0.25% to 2% of your loan balance per year. The costs depend on your credit score, loan terms, the number of deposits and mortgage. The more your risk factors, the more the rate you will pay. You can request that monthly PMI policy payments be cancelled once the LTV ratio gets below 80%. The lender is supposed to eliminate PMI when LVT ratio drops to 78%. This is possible if your interests and deposit equal to 22% of the property’s buying price.
Can you roll closing costs into a mortgage? Sometimes, if you’re refinancing a property with plenty of equity in it.
If you’re buying a property, you’re better off negotiating a seller concession to cover your closing costs. While you’re at it, consider negotiating a seller-held second mortgage – you could avoid coming up with a down payment entirely!
But there’s always a cost when you borrow money, both in up-front fees and in ongoing interest. By rolling closing costs into a loan, or borrowing part of the down payment, you end up with a higher monthly payment and a greater risk of negative real estate cash flow.
Have you ever included closing costs in a loan? How did rolling the closing costs into your mortgage work out for you?
More Savvy Real Estate Investing Reads:
About the Author
G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.