Buying a home? Expect to find mortgage fees and closing costs. You're going to pay. A lot. But how? What's the best way? Pay them all now... or a little bit at a time? Are you really always better off paying them out of pocket today? What are my options, and how will they work out for me?
For FHA or VA borrowers, upfront costs like the first year's mortgage insurance premium or funding fee can be included in the loan amount. In all cases, though, the question remains: "Is it better to pay closing costs and fees out of pocket, finance them into the loan amount, or trade them for a higher interest rate?" There's no one simple answer, since each choice has its own benefits and total costs over time. One may be more or less expensive depending upon how long you'll hold onto the mortgage. And yes, even a "no-cost" mortgage choice will have costs!
You can't escape running into the puzzle of proper "asset allocation." You'll need to decide how best to use your limited funds to cover a down payment and the fees and costs associated with getting your new mortgage. Even if all three methods aren't available to you, you'll usually need to compare at least two options.
HSH.com's FeePay Best Way closing cost calculator will allow you to run the numbers for a traditional method of paying those costs out-of-pocket against higher loan balance or even "no-cost" choices to help you see how the costs of each will work for you over time. Fill in the information once and compare the costs or savings the other choices might bring.
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The Traditional Method calculator assumes you pay the closing costs out of pocket today. We assume that typical fees will be approximately 2 points (2 percent of the loan amount) but if they are more or less you can change it; just type the expected total dollar amount into the Estimated Costs box.
In a Traditional method, you pay the fees once, and then they are gone.
The Higher Loan Balance calculation uses the Estimated Costs you plugged into the Traditional calculator, and adds them into the outstanding loan balance. If you are an FHA borrower, you should add in your up-front mortgage insurance premium (MIP) in the space provided in this calculator. If you are a veteran borrowing a VA-backed loan and will be financing all or part of the VA funding fee, make sure you add that cost here to get the most accurate results. A larger loan balance will raise your Loan-to-Value (LTV) ratio, and may affect the cost of or require you to obtain mortgage insurance, so you'll need to consider this cost if it applies to your situation.
Since you are financing the costs, you'll not only pay them but also interest on them. However, you are only paying them a little at a time, and depending upon how long you remain in the mortgage, they may cost you more or less than if you paid them right up front, as you would have using the Traditional method.
A "No-Cost" offer might be your best bet if you don't have cash to spend or available equity to commit toward your costs. Your loan will have a slightly higher than market interest rate, so your income will need to be sufficient to be able to handle the higher payment. If it isn't, this higher interest rate can lower the amount of the mortgage you can qualify for, and that might disturb your purchasing plans. We assume that the interest rate available for a "no-cost" mortgage will be a half-percentage point higher than if you had paid the fees. If a lender offers you something different, you can change the information in the box, then re-calculate the results.
In effect, since the whole amount of your loan will be exposed to this "higher-than-market" interest rate, this choice may cost you more over the long haul. If you're not planning on being in the mortgage for the entire term, this choice may work better for you, so run the numbers to see.
Below the initial calculations, we've provided some examples of your costs over time, including the interest cost and the remaining loan balance after a given period of time. This way, you can see what those costs will be at varying intervals. You might find, for example, that relative to your time frame, incorporating the fees into the interest rate might mean they cost you less in interest over a given period than the amount you might have paid out-of-pocket up front.
Before you add in your actual numbers, we suggest that you use the following example in order to make it easier to follow the discussion of savings comparisons below. Use a $100,000 loan amount, a 4% interest rate and a 30-year term, press calculate, then read the example results below the calculator.
Tip: Check current mortgage rates to make sure you are getting the best deal on your mortgage. Learn more about homebuying, mortgage qualification and more.
The Blue, Green and Orange displays below will allow you to see if paying or financing the costs of your loan works out for you over given time horizons. When you pay the fees up front, your interest charges will of course be lower over time compared with the other choices... but over how much time?
Note: you might not have all three choices available to you.
Let's say that after a year Traditional method has seen you spend a total of $3968 in interest cost. Over the same time, the Higher Loan Balance (HLB) interest cost is $4047, while the "No Cost" option has seen you pay $4467.
If you should suddenly sell your home after a year, your actual cost for the Traditional finance method would include the $3968 in interest, plus an additional $2000 in closing costs for a total of $5968, while the other choices would have cost $4047 and $4467 respectively, so you would have been better off with one of them.
Factoring in the differences in remaining loan balances does change the equation, though. At the end of the 12-month period you still owe $1965 more on the HLB than the traditional refinance, bringing the total of your HLB refinance to $6012, just slightly more than the paid-up-front choice.
However, building those costs into the interest rate means your "no-cost" choice has seen you spend $4467 in interest, plus the $148 differential in remaining balance - so the total cost after 12 months is only $4615, a clear winner... but only over this very short time horizon.
These relationships change over time, however. After 10 years, you've spent a lot more in interest charges in the "no-cost" method than you would have if you chose to pay costs or build them into the loan amount.
All this said, in order to determine what your best choice will be over time, you'll need to compare both interest costs and remaining balances among the various methods.
Closing Cost Calculator
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