What are closing costs?
Closing costs incorporate a bunch of charges before you finalize your mortgage. This applies to both buying a home or refinancing. While most closing costs will fall upon the buyer, there will usually be a few that the seller has to pay.
How much will I pay in closing costs?
Typically, home buyers will spend between 1% to 5% of the purchase price on these fees. On a $300,000 home purchase, you would be expected to pay somewhere between $6,000 to $15,000 on your closing costs.
Most pay the closing costs out-of-pocket as a one-time expense. There is also the option to finance your closing costs so that you spend less money upfront. Of course, you’ll pay interest on those costs through the life of the mortgage.
When Does It Make Sense to Finance Closing Costs
On the off chance that you’ve just spent an enormous portion of your savings on your down payment, financing your closing costs may be a smart move. It also may be worth considering if you are refinancing your home or applying for a home equity loan.
The rules for rolling closing costs into your mortgage are different if you are refinancing. So long as including the closing costs back into your mortgage doesn’t impact your debt-to-income (DTI) or loan-to-value (LTV) ratios too much, you may be able to roll closing costs back into your new loan.
Here’s an example, lets say your new loan amount is $200,000 and your home is valued at $250,000, that means your LTV is 80% (200,000/250,000= 0.80). If your maximum approval is 80% LTV, or you just want to stay at or below the 80% mark to avoid paying mortgage insurance, you may not be able to roll the closing costs back into your loan.
But If your loan-to-value ratio is low (meaning more equity in the home during your refinance), paying a small amount more each month might not make too much of a difference.
Is rolling closing costs into your loan the same as a “no closing cost” mortgage?
Short answer, no. Generally, when lenders publicize “no closing cost” or “zero closing cost” mortgages they are pulling a sleight of hand where they trade a slightly higher interest rate in return for “lender credit.”
Lender credit implies the mortgage company will cover part or all your closing costs.
The obvious downside is you’ll pay a higher monthly payment over the entirety of the loan and possibly a lot more in interest overall. In most cases, this is not advised but can be helpful when you also have to come up with a large down payment.
Does Financing closing costs into your mortgage reduce the amount of interest you can deduct?
Ordinarily, no, the amount of interest you can deduct from your taxes isn’t impacted by financing the closing costs into your mortgage.
Picking a slightly higher interest rate instead of closing costs, however, can give you a greater interest deduction. This is due to the fact you’ll be paying a slightly higher rate, which means paying more interest.
Be sure to contact a tax professional for your specific situation on what you can or can’t deduct. Our loan officers can also help with any questions you have about your mortgage, contact us here.