Crunching the Closing-Cost Numbers: How to Finesse Mortgage Fees
Taking out a mortgage is only done a handful of times in one's life. Whether you're buying a home or refinancing a mortgage, closing costs are an inevitable part of the transaction. And keep in mind, closing costs on purchase transactions cost more than they do for refinances. With that in mind, here are some little-known ways to absorb the fees necessary in taking out a mortgage loan.
Seller Credit: When buying a home, most mortgage loan programs allow for a certain percentage of the purchase price to be used for closing costs. In order to finance closing costs in a purchase transaction, the easiest way is to ask for a seller credit for closing costs. While lenders allow for a 3 percent credit, most need only 2.5 percent of the sales price. It's based off of purchase price, rather than loan amount (like a refinance is) because the sale value of the home is what the transaction hinges on. A seller credit for closing costs means the seller receives a smaller "net," and money literally comes out of their pocket.
Bigger Sales Price: As discussed above, in a seller credit situation the seller has to agree to a concession, giving up money for the greater good to make the deal happen. A buyer who can qualify for financing might be better served offering a higher purchase price, 2.5 percent over list price, for example, so the seller does not lose money and they still get the seller credit needed for reducing funds to close. Essentially, this means the buyer is financing the closing costs over 360 months (assuming a 30-year fixed rate) by virtue of a bigger loan against a bigger purchase price.
Bigger Loan: Let's say you plan to purchase a house for $350,000 and have $21,000, which by the way is the total needed to purchase a house at this price. Rather than asking for a seller credit for closing costs, you pay your own closing costs, $8,750, and the remaining $12,250 (3.5 percent down on an FHA loan) gets your foot in the door. The bigger loan is due to extra cash going towards closing costs, rather than down payment. In a refinancing situation it's simply a matter of inflating the loan amount and financing the fees over the term of the loan.
Inflate the Rate: This is also called a lender credit. It's the same way a no-cost refinance works, you agree to a higher interest rate in exchange for some sort of monetary concession from the lender paying a portion of the closing costs. It's not uncommon for a lender to be able to offer a credit anywhere from $2,000 to $4,000, taking a sizable chunk away from the fees. The risk to doing this is paying a higher interest rate over the term of the loan, which in the end, on an interest amortization schedule, can be pricier than coming up with the one-time monies needed for the loan to close.
The Cost of Financing: In short, when financing your closing costs, it's an interest expense. Consider this, it's an extra $37,703 more in interest over the life of 360 months (30-year fixed-rate) if you take a lender credit for $3,000 in exchange for a 4.875 percent interest rate, when 4.375 percent is otherwise currently available. It's also not uncommon to see a spread of 0.5 percent in rate in exchange for $3,000 closing cost credit.
The higher interest rate and loan amount does translate to a larger interest expense over time, assuming the loan is not refinanced (which, by the way, most are). The higher sales price also generates a larger loan amount and also generates higher property taxes. Why? Property taxes are based on a portion of the sales price of the property, and the subsequent assessment with your local county is based upon that sales price.
While financing closing costs can solidify your ability to close the transaction, it may still make sense to cash finance the fees. Be sure to comparatively look at your individual advantages and disadvantages of financing the closing costs. Closing costs are assessed every time the property is encumbered (financed). Expect closing costs on purchase transactions around 2.5 percent of the sales price; on refinances, 1 percent of the loan amount.
More on Credit.com:
How to Determine Your Down Payment on a Home
Why You Should Check Your Credit Before Buying a Home
How to Get Pre-Approved for a Mortgage
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