Do Mortgage Lenders Pay Buyer Closing Costs?
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Reader question: "I'm wondering if mortgage lenders ever pay the home buyer's closing costs. We have enough to cover the down payment on a home purchase, but we probably won't have much left over for the closing costs."
This is a common question among home buyers, especially those with limited funds in the bank.
The short answer is yes, mortgage lenders do sometimes pay the home buyer's closing costs. But they typically charge a higher interest rate as a result of covering those costs. So the home buyer still pays in the end.
The 'Zero Closing Cost' Home Loan
Banks and mortgage lenders sometimes offer what is known as a "zero closing cost" home loan. It certainly helps them capture the attention of cash-strapped home buyers. And in most cases these offers are legitimate. There are cases where the mortgage lender will pay closing costs on behalf of the borrower.
This can be a good financing strategy for home buyers who have enough money in the bank for the down payment — but not the closing costs.
It typically works like this:
The lender will agree to cover some, or even all, of the home buyer's closing costs and related fees. This is commonly referred to as "lender-paid" costs. To make up for that expense, they'll charge the borrower a higher interest rate on the loan.
The amount that they "mark up" the mortgage rate can vary from one lender to the next. The key thing to understand is that you'll end up with a larger monthly mortgage payment, as a result of taking on a higher rate.
So there are some obvious pros and cons to consider:
Pro: When the mortgage lender pays the buyer's closing costs, it enables the borrower to purchase a home with less money out of pocket. So it essentially lowers, or even eliminates, one of the barriers to homeownership.
Con: The downside to this financing method is that the home buyer / borrower ends up with a higher monthly payment, as a result of being charged more interest on the loan. If the borrower keeps the loan over a period of many years, they could end up paying significantly more (in interest charges) than what they would've paid in closing costs.
A Strategy for Home Buyers With Limited Funds
In some scenarios, the amount saved up front will end up costing more in the long run. So there's an obvious tradeoff here. Home buyers could pay less up front by having the mortgage lender cover some or all of the closing costs. But they might end up paying more over time.
For most people, this is an easy choice that's largely determined by how much money you have in the bank:
- If you can afford to pay your closing costs out of pocket, then it's probably best to do so. That would prevent you from being charged more in interest over a number of years.
- However, if you lack the funds to cover the down payment and closing costs associated with your loan, then it might be best to take on a higher rate and have the mortgage lender pay those costs.
Home buyers who opt for the lender-paid option need to understand how it will affect them over the long term.
Here are some key questions to ask:
- How much higher will the monthly payments be if the lender charges a higher rate (in exchange for paying the buyer's closing costs)?
- Will the monthly payments still be affordable?
- And how much more interest might you pay over the long term, if you let the lender cover your upfront costs?
Consider: How Long Will You Keep the Loan?
These days, people tend to move around more than in the past. It's actually rare for a person who takes out a 30-year mortgage loan to keep it for the full 30-year term.
A typical homeowner today will either sell the home and move, or refinance into a new mortgage — long before reaching the 30-year mark. And this is one of the key considerations to make, if a mortgage lender offers to pay your closing costs.
In a shorter stay of just a few years, for example, that higher mortgage rate probably won't result in a huge increase in total interest paid.
But with a longer stay, the difference becomes more pronounced and costly. Those extra interest charges can really add up over time.
Lender-Paid Closing Costs Might Work if…
There's a certain type of borrower who might benefit from having the mortgage lender pay their closing costs. This strategy is typically used by home buyers who:
- Can't afford to pay all of their closing fees upfront
- Plan to stay in the home (and keep the loan) for only a few years
- Need to keep some of their money in reserve for other purposes
On the flip side of the coin, this strategy is less suitable for buyers who:
- Plan to stay in the house (and keep the loan) for many years
- Want to minimize their monthly payments as much as possible
- Want to reduce the total amount of interest paid over time
Our Advice for Home Buyers
The Home Buying Institute has a long history of providing unbiased, straightforward advice to buyers. In keeping with that tradition, here's our best advice for borrowers considering this strategy:
- The most important thing is to make sure you can comfortably afford your monthly mortgage payments. Everything else is secondary to that.
- Not being able to afford your closing costs might be a warning sign that you are buying too much house, or that you're not ready for such a purchase. So you might consider waiting longer to save up more money.
- Make sure you understand how much your monthly payments will go up, if the mortgage lender pays your closing costs and charges a higher rate. Make an informed decision so you don't end up being "house poor."
Conclusion: Do mortgage lenders pay closing costs on behalf of home buyers? Sometimes, yes. It's a fairly common practice. But they almost always charge a higher rate on the loan, exchange for covering some or all of the borrower's upfront costs. So there's a tradeoff to consider.