FHA loan closing costs are a big factor in how much cash you need to buy a home. But there are ways to minimize your out of pocket expenses.
For many cash-strapped homebuyers, FHA loans are a godsend. The low down payment requirement of 3.5% allows you to purchase a home for less money out of pocket, even with a low credit score.
But the down payment isn’t the only expense to consider. FHA loans, like all mortgages, also have closing costs. Typically, those costs total between 2-5% of the loan.
The great thing about FHA closing costs, however, is that you can use gift funds or an assistance program to pay for them.
That means it’s possible to buy a home without paying for closing costs out of your own pocket. And that option makes FHA loans one of the most affordable mortgage programs out there.
All mortgages have closing costs, and FHA loans are no exception. The amount you’ll need to pay depends on where you live and how much you borrow.
The average closing costs in the U.S. were $6,087 including taxes, and $3,470 not including prepaid property taxes in 2020, according to real estate data company ClosingCorp.
But costs can vary substantially based on where you’re buying. Taxes can add a significant amount to your bottom line, but so can inspections.
If you live in a coastal area, for instance, you may need a flood inspection on top of a general inspection. Your homeowners insurance premium will also depend on where you live, including the neighborhood and the surrounding geography.
A good rule of thumb is to assume you’ll need 2-5% of your loan amount for closing costs.
When you get preapproved for an FHA loan, your lender will send you an estimate of your monthly payment and closing costs based on the amount for which you’ve been approved. That estimate can help you set your homebuying budget and gauge how much you’ll need in savings to close on the home.
Yes — your down payment and closing costs are distinct pieces of the total homebuying upfront expense. The down payment is the money you contribute to the cost of the house you’re buying, and your mortgage loan makes up the rest.
Related reading: FHA Loan Down Payment: Guide to 3.5% Down Homebuying
The closing costs largely cover your lender’s expenses and third-party fees that are essential to the transaction.
For instance, you might see a title search fee on your closing cost estimate. The title company researches the previous ownership and certifies there are no outstanding claims against the property.
You’ll also pay an appraisal fee. This is required by the lender to verify the home’s value and ensure that the home is in safe and livable condition.
There are many such aspects to the process, and your closing costs cover those expenses.
You can expect FHA closing costs to be around 2-5% of the home’s purchase price.
The figure will be on the low side of that range for more expensive homes and on the high side for lower priced homes.
For instance, a $400,000 home may require $8,000 in closing costs including paying 6 months of property taxes and 1 year of the homeowner’s insurance policy upfront. That’s just 2%.
But a $150,000 home could require $5,000 in closing costs, which is 3.3% of the home price.
There are fixed costs such as processing fees, underwriting fees, and appraisal costs that don’t change much whether the home is $50,000 or $1 million. So percentages can be misleading.
FHA loan closing costs will vary from loan to loan, and borrower to borrower. For example, not all mortgage lenders charge origination fees. Appraisals are usually around $500, though they can be more or less than that. That’s why it helps to get a loan estimate, so you have a ballpark of what your costs will look like.
But here’s an overview of what might be included — and how much you might pay.
Remember, these are estimates. Many of these costs vary significantly. Not all states require that an attorney be involved. And in those that do, the attorney’s fees can vary from firm to firm. Additionally, not all properties will need a survey.
This list isn’t exhaustive, either. Other potential costs include credit report fees, flood certification fees, and prepaid daily interest charges. The daily interest charges apply to the period between when your loan closes and the first day of the next month.
Understanding all of the different costs can feel overwhelming once you see them on paper and the reality of buying a home sinks in.
But your lender is there to help you make sense of it all, so ask questions until you’re clear on the costs and feel confident that you understand what you’re paying.
**FHA appraisals tend to be more rigorous and complex than those for conventional loans. The appraisal fee may be a bit higher for an FHA loan.
FHA loans require you to pay an upfront and annual mortgage insurance premium (MIP).
The upfront fee is 1.75% of the loan amount and is due at closing, but you also have the option of rolling it into the loan.
Doing so increases your loan amount, so you’ll pay more over time. But if you’re worried about having enough to close, this can be a good way to give yourself some breathing room.
The annual MIP rate depends on your down payment and loan amount. Most FHA borrowers pay 0.80-0.85% in annual MIP. The yearly fee is paid in 1/12th installments along with your monthly mortgage payment.
Some lenders give you the option to “buy down” your interest rate at closing. For example, you pay 1% of the loan amount in exchange for the rate being lowered by a certain percentage.
Buying down the rate doesn’t make sense for everyone, especially if you plan to sell the home or refinance within a few years. You want to have the loan long enough to break even on the higher costs.
Two big upfront costs are your prepaid property taxes and homeowners insurance. These aren’t closing costs, but you will need to pay them before you take possession of the home, so you’ll need to account for them in your homebuying budget.
You’ll pay the first year of taxes and insurance upfront (hence the term “prepaid). That’s one reason closing costs are so variable. If the local property taxes are high, they can add substantially to the amount of money needed upfront to close.
Same goes for homeowners insurance. Fortunately, you can — and should — shop around for the best rate. You may be able to save money by bundling your homeowners insurance with other policies, such as your car insurance.
If calling around to multiple companies for quotes sounds overwhelming on top of all the other to dos associated with buying a house, you can go through an insurance agency. They’ll shop around for rates for you and can help you get set up with a new policy.
There are a lot of individual costs that add up to your final closing cost number.
Fortunately, you don’t have to pay all of these piecemeal throughout the process. Before closing, your lender will tell you the cash needed to close, and you can pay that as a lump sum.
You will wire funds or bring a cashier’s check to closing when you sign final loan documents near the end of the process. So make sure you have all necessary funds in a checking account a few weeks before your closing date.
If you put down any earnest money or a due diligence fee when you made the offer on your home, those deposits will be credited toward your closing costs.
FHA loans are often among the most affordable home loan options because of the low down payment requirement and competitive interest rates.
But every dollar counts when you’re buying a home, especially if you’re a first-time homebuyer.
Here are three ways to reduce your out-of-pocket expenses:
FHA loan closing costs be included in the loan? You can include the FHA upfront mortgage insurance fee of 1.75% in your loan if you don’t want to pay it at closing. Other costs cannot be financed, such as your prepaid property taxes, homeowners insurance, and daily interest charge.
If you’re worried about being able to afford your closing costs on an FHA loan, you can use gift funds or closing cost assistance to cover those expenses.
What are the typical FHA closing costs? Closing costs usually total between 2-5% of the loan, on the higher end of that range for less expensive homes and lower percentages on high-cost homes. On a $200,000 loan, your closing costs might be around $6,000 (3%), and on a $400,000 home, perhaps around $8,000 (2%). Your upfront costs will vary based on your lender and where you live. Lender fees are different company to company. Additionally, local property taxes can significantly affect the amount of money you’ll need to close. You need to prepay around 6 months of taxes when you buy a home. So if taxes are $150 per month, prepaid taxes are not as big a deal as if the home’s property taxes are $700 per month.
FHA loans also carry an upfront mortgage insurance fee of 1.75% of the loan, though this can be rolled into your mortgage.
What is the maximum closing costs on an FHA loan? There isn’t a cap per se on FHA loan closing costs, though there are ways to estimate how much you’ll pay. Closing costs usually max out at 5% of the home’s cost, but a percentage this high typically means you’re buying a very inexpensive home.
The best way to find out what you’ll pay in closing costs is to get preapproved with an FHA mortgage lender. They’ll tell you how much you qualify to borrow and what your estimated closing costs will be.
If you’re ready to buy a home but are a little daunted by the upfront costs, know that there are ways to make it work. Closing cost assistance, gift funds, negotiating lender fees — these are all strategies you can use to get into a new home for less.
But first things first. Get preapproved with an FHA lender to find out how much you can borrow, how much your closing costs will be, and what you can do to bring that number down.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA, and were not approved by a government agency.
*Pre-approval is based on a preliminary review of credit information provided to Fairway Independent Mortgage Corporation, which has not been reviewed by underwriting. If you have submitted verifying documentation, you have done so voluntarily. Final loan approval is subject to a full underwriting review of support documentation including, but not limited to, applicants’ creditworthiness, assets, income information, and a satisfactory appraisal.
***Eligibility subject to program stipulations, qualifying factors, applicable income and debt-to-income (DTI) restrictions, and property limits.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.
