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FHA Closing Costs: What Should I Budget For?

If you’re looking to buy a new home, especially your first, consider opting for an FHA loan. These loans, akin to conventional ones, are usually easier to qualify for and more cost-effective in the long term. However, similar to conventional loans, FHA loans also entail closing costs. 

Let’s dive into what comprises FHA closing costs and explore strategies to minimize them.

Understanding FHA Closing Costs

When purchasing a home using a mortgage, you should have two cash reserves prepared for the closing. One is for the down payment, and the other is for covering the closing costs.

Regardless of the mortgage type chosen, closing costs are inevitable. It’s advisable to budget between 3% to 6% of your total loan amount for these expenses.

While the closing costs for an FHA loan are similar to conventional loans, the specific breakdown of costs and fees may vary slightly.

Exploring the Advantages of an FHA Home Loan

FHA loans, a form of non-conforming loan accessible through private lenders, cater to low- and moderate-income earners. They are government-insured and serve as an alternative for those who may not qualify for conventional loans. These loans typically demand only a 3.5% down payment and are open to individuals with prior credit challenges and lower credit ratings.

Moreover, FHA loans provide flexibility concerning debt-to-income ratios (DTI) and allow for manual underwriting. This human-centered approach enables borrowers to present explanations for past credit issues directly to decision-makers, rather than relying solely on automated algorithms.

Exploring further, we will delve into the breakdown of closing costs associated with FHA loans, along with effective strategies for minimizing them.

Examining FHA Closing Costs in Depth

What expenses are home buyers covering at closing? The process of buying a home and securing an FHA mortgage involves various components. Let’s delve into the potential costs you might need to manage.

Mortgage Insurance Premium (MIP)

A mortgage insurance premium (MIP) serves as the FHA’s equivalent of private mortgage insurance (PMI). While buyers with a conventional mortgage pay PMI until they achieve 20% equity in their home, MIP functions a bit differently. The FHA uses MIP to support its operations through an upfront payment at closing – 1.75% of the purchase price – and an annual MIP component that is spread out and included in your monthly mortgage payment. The monthly MIP expenses you incur will vary based on your loan amount, down payment size, and repayment term duration.

Lender Fees

When you submit your mortgage application, your lender initiates the underwriting procedure to evaluate the level of risk you pose as a borrower, analyzing your financial details. Subsequently, the lender collects and examines your information, organizes all necessary documents for closure, and may propose additional features such as a mortgage rate lock fee.

The home buyer repays the lender for these services by making the following payments:

  • Loan Origination Fee
  • Underwriting Fee
  • Document Preparation Fee
  • Supplemental Loan Origination Fee
  • Interest Rate Lock Fee

Third Party Fees

While your situation and location may vary, the following list outlines the typical third-party fees that home buyers commonly encounter at closing.

  • Premium for the owner’s title insurance policy.
  • Notary fee
  • Credit report fee
  • Recording fees at the county clerk’s office.
  • Appraisal Fee
  • Courier fee
  • Attorney Fees
  • Flood certification fee

Prepaid Expenses

Prepaid expenses, while not classified as closing costs, are typically paid around the same time. Therefore, it’s beneficial to regard them as part of the same expenditure group. These encompass costs such as prepaid insurance, taxes, interest, and initial escrow payments at closing.

How Much Should I Expect To Pay in Closing Costs?

Typically, closing costs range from 3% to 6% of the home’s purchase price. The initial MIP payment, usually at 1.75% of the purchase price, can make FHA loans slightly pricier initially.

When Will I Be Provided My Exact Closing Costs?

You will be sent a Closing Disclosure at least three business days before the closing date. This document will detail all your costs and dues accurately.

It’s crucial to review the Closing Disclosure meticulously to ensure its accuracy. It should encompass all the pertinent details about your loan. Following receipt of the Closing Disclosure, schedule a meeting with your agent and/or real estate attorney to address any queries you may have until you are fully satisfied.

Is it possible to include my FHA loan closing costs in the loan amount?

The FHA offers the option to include financing costs in your mortgage, creating a no-closing-cost mortgage where these costs are rolled into your principal balance. However, it’s important to note that by rolling closing costs into the principal, you’ll also be paying interest on these costs. This can result in higher overall interest expenses throughout the mortgage term.

Tips for Lowering My FHA Closing Expenses?

Closing costs can feel overwhelming when combined with your down payment and other home buying expenses. Here are some effective strategies to lessen the financial impact of these costs.

Seller Concessions

Seller concessions are a method for sellers to alleviate some of the buyer’s expenses, easing the financial burden at closing. Essentially, the seller agrees to cover certain costs for the buyer. In a seller’s market, negotiating concessions can be challenging as sellers hold the advantage. Conversely, in a buyer’s market, buyers may request sellers to cover some closing costs without compensation.

To prevent inflation of housing prices, government regulations restrict the amount a seller can contribute towards a buyer’s expenses. This limitation exists to avoid scenarios where a house is sold for a lower price but with substantial concessions. Consequently, the FHA imposes a cap of 6% of the purchase price on seller concessions.

Ask Your Lender

The saying “it never hurts to ask” applies in dealings with mortgage lenders as well. For example, your lender could be open to waiving courier or wire transfer fees upon request. Although success is not assured, there is always a chance. Do not hesitate to engage in negotiations with your prospective lender. The worst-case scenario is a straightforward ‘no.’

Gift Funds

Rules govern the use of gift funds when applying for a mortgage. Those opting for conventional mortgages must justify the funds in their accounts. Lenders usually require an explanation for gifts exceeding half the household’s monthly income.

For instance, if your parents gift you $10,000 towards your home purchase and this amount suddenly appears in your bank account during the home buying process, you will likely need to provide a gift letter to confirm that these funds are not a loan.

To qualify for an FHA loan, adherence to FHA regulations is mandatory. This loan permits the utilization of gifts from these sources for covering your down payment and closing costs.

  • Family members of the borrower
  • Borrower’s employer or labor union
  • A close friend with a vested interest in the borrower
  • A charitable organization
  • A governmental agency supporting low to middle-income families or first-time home buyers

Down Payment Assistance Programs

Various government programs and housing nonprofits are dedicated to aiding first-time or low- to moderate-income earners in achieving homeownership, a key pathway to building wealth in the U.S. Typically, assistance for first-time homebuyers is accessible to those who haven’t owned a home in the past 3 years.

The Department of Housing and Urban Development (HUD) curates a comprehensive database of local resources that offer support for home purchases. Explore whether your state or city provides assistance that could facilitate your journey to closing with the necessary funds.

FAQs on FHA Closing Costs

Navigating the complexities of mortgages can feel daunting when you’re new to the process. Rest assured, we’re here to provide clarity and address all your inquiries about purchasing a home.

Does an FHA loan cover closing costs?

You have the option to include your closing costs in the loan amount and repay them alongside the principal, known as a no-closing-cost loan. However, there is a drawback: you will accrue interest on the closing costs, making it potentially more costly in the future.

Where can I obtain an FHA loan?

Elevation Mortgage provides conventional, FHA, and VA loans, aligning with FHA requirements. While not all lenders offer FHA loans, many do. It’s wise to explore different lenders to understand their offerings fully.

Is it possible to purchase a multiunit home using an FHA loan?

The FHA classifies a single-family home as a dwelling with one to four units. You’re eligible to utilize an FHA loan for acquiring a multiunit, single-family home, provided that you reside in one of the units for at least one year.

Why do sellers often reject offers accompanied by FHA mortgage preapproval letters?

When utilizing a government-insured loan for acquiring a home, it must adhere to the government’s livability criteria. Consequently, the FHA appraisal process may lead to complications and setbacks. Hence, when presented with multiple options, numerous sellers opt for a conventional mortgage or, ideally, an all-cash proposition to avoid such issues.

What exactly is an FHA 203(k) renovation loan?

Should the house you wish to purchase using your FHA loan fall short of the U.S. Department of Housing and Urban Development (HUD)’s livability criteria, you could explore applying for an FHA 203(k) renovation loan to address the necessary repairs for ensuring the home’s safety and integrity. Once the renovations are done, you can transition into your freshly refurbished living space with both loans consolidated into a single monthly payment.

Who covers the commissions for real estate agents?

Historically, sellers have typically covered commissions. Nevertheless, there is room for negotiation, allowing either the buyer or seller to take on this cost. Consult your real estate agent to understand the nuances of this arrangement and its impact on your expenses.

Key Takeaway: Closing Costs Are a Necessary Expense When Securing a Mortgage

Regardless of the mortgage type you select, closing costs play a significant role in your home buying journey. Due to the upfront MIP, FHA closing costs tend to fall on the higher end of the common 3% – 6% range. However, this does not detract from the benefits of an FHA mortgage, which offers advantages like a low down payment, reduced interest rates, and flexible underwriting.

Ready to apply for your FHA or conventional loan? Take the next step by applying online now to discover the optimal financing option tailored just for you.

Picture of Reed Letson

Reed Letson

Reed offers two decades of expertise as a mortgage broker, focusing on veterans and first-time home buyers. With a strong grasp of real estate and mortgage markets, he empowers clients with practical insights. Reed's passion is guiding clients to build wealth through real estate investments and financing solutions.

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