All mortgage loans have closing costs. Lenders charge origination fees, certain ongoing expenses of homeownership need to be paid in advance, and there are several other common expenses buyers are expected to pay when a real estate transaction is finalized.
FHA mortgage loans have several closing costs buyers can expect to pay, some of which are common among all mortgage loan types, and others which are unique to FHA loans. Here's a rundown of FHA mortgage loan closing costs, how you might be able to get out of paying them, and how to reduce your out-of-pocket expenses at closing.
What is an FHA mortgage loan?
An FHA mortgage loan is a type of home loan that’s designed to make it easier for Americans to purchase a home to live in. FHA loans have flexible down payment requirements, with most borrowers having to put just 3.5% of the purchase price down.
FHA loans also have flexible credit requirements. While conventional mortgages require a minimum FICO® Score of 620, the minimum for an FHA loan with a 3.5% down payment is just 580. If you can come up with 10% down, you could get an FHA mortgage with a credit score as low as 500.
FHA mortgages also have flexibility when it comes to closing costs. While FHA loans have closing costs just like any other mortgage, there's quite a bit of leeway when it comes to including FHA closing costs in the loan itself or asking the seller to pay them for you.
What closing costs will you have to pay with an FHA mortgage?
Most of the closing costs you'll have to pay are the same expenses, regardless of the type of mortgage you get. For example, most lenders will charge mortgage applicants a fee for running their credit report and any county taxes are the same, regardless of how you finance your home purchase. On the other hand, some can be more expensive with an FHA loan and others are unique to this type of mortgage. Here's a list of the most common FHA closing costs you can expect to pay when you obtain an FHA mortgage loan.
Mortgage insurance premium -- Most mortgages with a down payment of less than 20% require the borrower to pay mortgage insurance on an ongoing basis, but FHA loans have an up-front mortgage premium as well. This is equal to 1.75% of the loan amount.
Prepaids and escrows -- FHA mortgages, like most others, require the borrower to prepay a certain amount of property taxes, insurance costs, and/or mortgage insurance premiums, and put a certain additional amount for future use into an escrow account at closing. These costs can vary significantly depending on where the home is located.
Origination fees -- FHA lenders typically charge an origination fee, but for this specific loan type, the origination fee is capped at 1% of the principal amount. In other words, if you obtain a $150,000 FHA home loan, your origination fee can be as much as $1,500.
Other lender fees -- In addition to the mortgage origination fee, there are some other fees your lender may charge, such as an underwriting fee, document preparation fees, interest rate lock fees, and others.
Discount points -- Lenders often give borrowers the option to get a lower fixed interest rate in exchange for an up-front payment, known as "discount points." In mortgage terms, one discount point is equal to 1% of the loan amount.
Appraisal fees -- Most mortgage lenders require an appraisal, but FHA loans require an appraisal by an FHA-approved appraiser to ensure the property meets HUD's minimum property requirements. The average cost of an FHA appraisal ranges from $300 to $500, but it could potentially be more or less than this range.
Other expenses -- You may have to pay certain other costs at closing, including but not necessarily limited to title insurance premiums, notary fees, deed recording fees, credit report fees, courier fees, attorney fees, and flood certification fees.
In total, you can reasonably expect these closing costs to add up to 3%-4% of the loan amount. In some cases, this can be more or less, but this range is a good rule of thumb to use for budgeting purposes.
You can ask the seller to pay for closing costs
Another important concept to understand is seller-paid closing costs. With an FHA loan, the seller is allowed to contribute as much as 6% of the purchase price (or the home's appraised value, whichever is less) to help cover the buyer's closing costs, prepaid property taxes and insurance, discount points, and other out-of-pocket costs of acquiring the property.
To be sure, FHA closing costs rarely reach 6% of a home's value. When my wife and I used an FHA mortgage to buy our first home about a decade ago, our closing costs added up to approximately 4% of the purchase price and the only reason it was that high was above-average insurance costs (we lived in a hurricane-prone area).
The way this process works is that you'll include seller-paid closing costs as part of an offer. About 3% seems to be more of a standard figure, so you might offer "$200,000 with the seller contributing as much as 3% of the purchase price towards the buyer's closing expenses." One of the main points of using an FHA loan is to keep out-of-pocket expenses to a minimum, so it shouldn’t be too surprising that offers from FHA borrowers frequently include some level of seller-paid closing costs.
You don't have to pay these costs at closing
Finally, it's important to mention that even if the seller doesn't agree to pay closing costs, it doesn't necessarily mean that you have to come up with the cash to pay these closing costs at the time of your closing.
As mentioned earlier, one of the perks to an FHA mortgage is the low out-of-pocket cost. So not only is the down payment requirement just 3.5% for most borrowers, but most of your closing costs can be financed into the loan. This includes your origination fee and the rather costly FHA mortgage insurance premium, just to name a couple.
On the other hand, there are some closing costs that cannot be rolled into your mortgage -- specifically your prepaid property taxes, homeowner's insurance, and other escrow items. Any prepaid interest you owe at closing (you typically pay interest from the time of closing until your first mortgage payment is due) also cannot be included. These costs can be paid by the seller as part of any seller-paid closing cost agreement you may have, but they can't be added to your principal balance.
However, the ability to include most of your closing costs in the loan can certainly help reduce your out-of-pocket costs.
The Millionacres bottom line
FHA loans certainly have closing costs, and they tend to be 2%-3% of your loan amount. However, you have the option of rolling these costs into your loan balance, or you can even ask the seller to cover them as part of your offer. So while it's important to know the true cost of buying a home and borrowing money, it's also important to know that you don't necessarily need to pay FHA loan closing costs at the closing table, and you may not have to pay them at all.
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