Financing closing costs on an FHA mortgage can be confusing. In fact, many buyers don’t even realize that closing costs can actually be financed. Mortgage borrowers with less-than-perfect credit, minimal down payment funds or low incomes often turn to Federal Housing Administration (FHA) loans when buying or refinancing their homes. FHA-approved lenders are able to make loans to borrowers because the government agency reimburses them if the loans go bad. The loans also offer low closing costs, according to the Department of Housing and Urban Development, which oversees FHA programs. You can finance closing costs on an FHA loan several ways, to the extent that your loan amount doesn’t exceed the allowable loan-to-value ratio. The LTV represents the relationship between your loan balance and your home’s value.
While FHA requirements define which closing costs are allowable as charges to the borrower, the specific costs and amounts that are deemed reasonable and customary are determined by each local FHA office. All other costs are generally not allowed and are usually paid by the seller when buying a new home, or paid by the lender when refinancing your exising FHA loan.
Purchase: Ask the seller of the property on a sales transaction to pay for your closing costs. FHA allows a seller to pay a maximum of 3% toward a buyer’s recurring and non-recurring closing costs, which include third-party service fees and lender fees, or points.
Include the seller concessions: You can include concessions of up to 3 percent on the sales contract: The concession can also be reflected on a contract addendum or counter-offer form. Seller-paid closing costs may be negotiated as a dollar amount or a percentage of the sales price.
Request an amount equal to or less than your estimated closing costs: Your FHA lender is required to supply you with a good-faith estimate, which will help you determine how much to ask for. Typically, any surplus of seller-paid concessions will be used to reduce your loan balance because FHA doesn’t allow you to receive cash back from seller-paid closing costs.
Refinance: Roll your refinance closing costs into your new loan balance. An FHA refinance pays off a previous loan with proceeds from a new loan. It can also pay the closing costs up to the allowable LTV.
Reduce the loan amount: If you can, reduce the loan amount to meet the LTV limit for your FHA loan: You can pay part of your own closing costs out-of-pocket at closing or negotiate with your lender to reduce its fees. You may also ask third-party service providers, such as title and escrow agents, to lower their fees.
Request a “no-cost” refinance from your FHA lender: Your transaction incurs closing costs, but your lender covers them through a yield spread premium, rather than directly financing them into the loan. You indirectly finance the costs because your lender gives you a higher interest rate in exchange for paying the closing costs on your behalf.
Final tips to take away:
Requesting seller-paid closing costs often involves offering the seller a competitive price. The FHA allows you to indirectly finance your closing costs using seller concessions as long as the sales price does not exceed the allowable LTV; usually a little over 96% or exceed the maximum allowable amount of 3 percent.
The FHA allows you to finance closing costs on all transactions, except for the streamline refinance. The streamline refinance involves minimal income and credit qualifying, and may be completed without an appraisal. The streamline process must result in a net tangible benefit to the borrower of a lower payment or other qualified advantage.