When applying for a mortgage, you may be able to finance some of your closing costs into the loan amount. While this will reduce your out-of-pocket expenses, it will also increase your monthly payments and the effective interest rate you'll pay over the term of the loan. This calculator can help you figure out the effect.
Interest rate vs. APR
When comparing mortgages, there are two different interest numbers to look at. The first is the loan's interest rate. This number tells you how much interest you'll be charged on the principal balance of your loan. It doesn't account for any other variables.
The annual percentage rate, or APR, is the more important metric, as it tells a more complete story of how much your mortgage will actually cost. This figure includes the interest you'll pay on the principal, as well as other costs such as discount points, brokerage fees, and other charges you pay to get the loan. In other words, the APR shows you the effective interest rate including all loan-related costs you'll have to pay, and therefore it offers a more apples-to-apples comparison of different loan options.
To illustrate this, I ran a mortgage quote on Zillow, and three of the loans that came up all had interest rates of 3.5%. However, the fees were significantly different among the loans, at $70, $731, and $1,197, respectively. This made the APRs a little different: 3.502%, 3.525%, and 3.540%, respectively. If these fees and other closing costs were actually paid at closing, then the monthly payments for these three loans would be the same, as the exact same interest rate would be applied to the principal balance.
Financing these costs makes your actual interest rate rise, and therefore it can result in a higher monthly payment.
What closing costs might you be able to finance?
Closing costs are typically between 2% and 5% of the loan amount depending on several factors, including the loan type and the dollar amount of the principal.
This isn't necessarily an exhaustive list, but some of the closing costs you may be able to finance into your mortgage include:
- Origination fee
- Lender fees for processing and underwriting
- Discount points -- i.e., money you pay in exchange for a lower interest rate
- Credit report fees
- Appraisal costs
- Title insurance
- Reconveyance fee
- Deed recording fees
- Wire and courier fees
- Endorsement fee
- Title closing fee
- Title document prep fee
Some of these costs can vary dramatically based on the type of loan you're getting and where you live. This is especially true of the costs that are paid to your local government, such as recording fees.
How financing the closing costs will affect your interest rate
Once you have a list of your estimated closing costs, which should be available on the good faith estimate (GFE) provided by your lender, you can determine how much financing the closing costs will affect your interest rate.
Here's a calculator that can help you do just that:
The bottom line
If you don't have a ton of cash sitting around, then it can be a good idea to finance your closing costs. However, be aware that doing so means you'll pay significantly more in interest over the term of your mortgage. If you do have the cash available, then you should figure out exactly how much you'll pay to finance your closing costs and then make the best financial decision for you and your family.