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Can you finance closing costs into a mortgage?

The most common barrier for first-time homebuyers is not having enough money saved to qualify for a mortgage.  It’s misconception that you need a 20% down payment to purchase a home, there are various mortgage programs that have low down payment options, some as little as 3% down, and with the backing of agencies in some states, you can actually buy a home with no money down.  However, one item buyers may not be knowledgeable about is the additional costs of financing when buying a home.  Mortgage closing costs and other related fees can total as much as 5% of your purchase price, which can be more than the actual amount required for down payment!

Can you finance closing costs into the mortgage?  The short answer is no.  There are no mortgage programs that allow you to finance the closing costs, but there are ways you can structure the purchase of a home to defray your out of pocket expense.

The first option is to negotiate with the seller to have them pay your mortgage closing costs.  Let’s say you find a home listed for $300,000.  Unless you are in a very hot market, most home sellers expect to negotiate the price of the home.  While some sellers are willing to negotiate more than others, it’s safe to say, an offer that is within 95% of the asking price is going to be taken seriously.  Rather than offering 95% of the asking price, or $285,000, you might offer $290,000 and ask the seller to pay $5,000 in closing costs.  At the end of the day, the net price you’re paying and the net amount the seller profits is the same, but you have now reduced your out of pocket expense by $5,000.

Here’s how the numbers break down in the two scenarios:

Purchase price – $285,000                                        $290,000

Down Payment (3%) – $8,550                                    $8,700

Closing Costs – $5,000                                               Paid by seller

Total Money Needed – $13,550                                   $8,700

As you can see, your down payment is $150 more, but you have now reduced your out of pocket expense by $4,850.  It may be a bit confusing, but in a roundabout way, you have financed your closing costs by increasing the purchase price of the home and borrowed more money, in doing so, you have reduced the amount of out of pocket money needed to buy a home.

The second way to avoid paying mortgage closing costs out of pocket is to pay a higher interest rate and have you lender give you a credit towards closing costs.  Mortgage lenders earn their profits from the spread between what they charge you for the interest rate and the rate offered by their investors.  For example, the investor’s rate might be 4%, and the lender charges you 4.25%.  The income paid by the investor for getting the higher rate is paid to the lender., think of it as the wholesale vs. retail rate.   If the lender charges you 4.375% or 4.5% rather than 4.25%, their profit margin is higher.  Your mortgage lender can pass that extra profit margin to you by paying some or all of your closing costs.  In recent years, the additional profit margin lenders receive by charging a higher rate (called a buyup), so the profit margin is less, so this may not be the best option at this time, but if you are stretched for cash,  it is worth exploring with your lender to see how much of a credit they can give.  In this scenario, you’ll be paying more interest each month, but it’s a great way to enter the housing market if you don’t have too much money in savings.  It’s also a good way to keep some of your nest egg in reserves to fall back on if you have a financial setback, or get hit with unexpected repairs.