Thinking About Rolling Closing Costs Into a Mortgage? Consider These Pros and Cons

Closing costs can be expensive -- but you should read this before you borrow for them.

When you purchase a home you are going to have to pay closing costs. These are fees for things like mortgage origination and transfer taxes. And they can be quite expensive. In fact, you can expect to pay around 2% to 5% of the value of the home in closing costs, so that's thousands -- or even tens of thousands -- of dollars.

Closing costs can be paid at the time when you complete the purchase of your property and ownership is transferred. But it can sometimes be difficult to come up with all that money at the same time as you must make a down payment. You have another option, though. You may be able to roll closing costs into your mortgage, which means you will borrow to pay them and then pay the borrowed funds off over time along with your home loan.

While this may seem like an easy solution to the problem of having to pay out tons of money to close on a home, there are pros and cons of this approach and you need to consider both to decide if this is right for you.

Advantages of rolling closing costs into your mortgage

Here are some of the biggest benefits of including closing costs in your mortgage and paying them as part of your monthly bills.

• You don't have to come up with a lump sum payment upfront: When you already have to save tens of thousands of dollars for a down payment, saving several thousand extra can feel like a huge burden. It may be easier to pay a little bit extra each month rather than try to accomplish this feat.
• You may be able to buy a house sooner: If you have to pay closing costs upfront, this may delay your purchase as you save more money. You won't start building equity as quickly if you have to put off becoming a homeowner.
• They will effectively become cheaper to pay over time. If you take out a fixed-rate mortgage and roll closing costs into it, you will not see your payment increase for the life of the loan. But the value of your money is continually going down due to inflation. So a $1,500 monthly mortgage payment today is still going to cost $1,500 25 years from now, but $1,500 won't buy you nearly as much at that time so you're effectively paying your loan with money that's worth less.

Disadvantages of rolling closing costs into your loan

While there are clearly benefits of rolling closing costs into your loan, there are also downsides as well. These include the following:

• You will be paying interest on closing costs. Since you're adding this amount onto your mortgage balance, you'll pay interest on the fees so they will become more expensive due to that added cost.
• You could affect your loan-to-value ratio adversely. Lenders have a limit on how much they will loan you relative to the value of the home. If you exceed this limit, you won't be able to borrow any more money -- and this could easily happen with closing costs. If you borrow more than 80% of what your home is worth, you also have to pay for private mortgage insurance to protect against financial loss for a lender in case of foreclosure. If you borrow for closing costs, you're more likely to exceed an 80% loan to value ratio.
• You'll be paying closing costs for decades. It will take a long time to pay off the closing costs with your monthly payments.

For many people, the benefits outweigh the advantages -- if your lender allows you to do this. But be aware that you'll be paying closing costs for a long time and that the interest costs added on will make your loan more expensive than it otherwise would have been. If you're OK with that, you may decide borrowing for closing costs is the best move for you.