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Financing Your Closing Costs

There are two ways to finance closing costs

Lender/Broker Paid
Seller Paid

Lender / Broker Paid Costs

Assume you are doing a refinance and are obtaining a new interest only loan for $500,000 at 6.0%; for simplicity, lender fees are $1,250, and escrow/title fees are $1,875--the total is $3,125. If you do not want these closing costs to reduce your cash out, you could ask the lender or mortgage broker to raise your interest rate sufficiently to offset these costs.

The $3,125 in costs works out to 0.625% of $500,000. As a rule of thumb, your would need to raise your interest rate about one-half of the 0.625% to offset costs. In this case, you would have to accept a rate between 6.250% and 6.375%, which is determined by the supply and demand of money at the time the loan is locked. Let's say that your were able to get the better rate of 6.25%, how do you determine if this makes sense for you. There are several factors that may influence your decision, namely:

How important is the extra cash on the short run, and how much are you willing to pay for it on the long run?
How long do you plan on keeping the loan?

Interest differential, paying 6.25% versus 6.0%:

Year 1.0: $1,250 (.25% x $500,000) x 1.0
Year 2.0: $2,500 (.25% x $500,000) x 2.0
Year 2.5: $3,125 (.25% x $500,000) x 2.5
Year 3.0: $3,750 (.25% x $500,000) x 3.0
Year 4.0: $5,000 (.25% x $500,000) x 4.0
Year 5.0: $6,250 (.25% x $500,000) x 5.0

If you plan on keeping the loan longer than 2.50 years, it makes sense to pay the closing costs upfront, unless you have more important reasons for retaining the cash now,

OR you plan to sell the house in less than 2.50 years, you would be a few dollars ahead by taking the higher rate assuming you do not have a 3-year hard* prepayment penalty.

* A hard prepay means that if you refinance or sell, you will incur a prepayment penalty. A "soft" prepay means that if you refinance you will incur a prepayment penalty, but you can sell without penalty. A prepay penalty is usually 80% of 6-months interest on the original loan amount. The reason that it is 80% is that you are allowed to pay down 20% during the prepayment period without penalty.

Seller Paid Costs

Assume you are doing a purchase and the seller wants $615,000 and you would like to minimize your cash outlay to no more than about $125,000 (i.e. 80% LTV). Ask the seller to accept an offer of $625,000 and give you a credit of $10,000 at closing to apply toward your non-recurring closing costs.

'A' lenders generally allow the seller to pay up to 3% of the purchase price or total sum of closing cost, whichever is less, and subprime (i.e. 'B-D') lenders allow for up to 6%!! The critical question when attempting this is whether the property will appraise for the additional $10,000.

Savvy sellers and real estate agents will realize that the seller will be paying some extra costs involved with the $10,000 higher price. Firstly, real estate commission: this cost can be easily eliminated by the agent(s) agreeing to base sales commission on the $615,000 amount. Secondly, additional taxes and title costs on the $10,000 (depending on the property state); the seller can either accept the fact he will net slightly less, or allow your $10,000 increase in price but only give you say a $9,500 credit. Don't be surprised that you may need to educate the real estate agent so he can educate the seller on this strategy. When agents and sellers do not understand something---the response is to reject the offer.

By getting the credit at closing, you are effectively financing 80% of your closing costs. Higher loan-to-value (LTV) loans such as 100% owner-occupied purchases work the best!! In order to get the better rates and terms, you need great credit (i.e. FICOs 700-740).

NOTE: You can use the Lender/Broker Paid costs in conjunction with Seller Paid costs!!!!!!!