Should I Finance My Closing Costs When I Refinance My Mortgage?

When refinancing your mortgage, you may have the option to finance your closing costs instead of paying them out of pocket. What does it mean to finance your closing costs? It’s when you add the expense associated with your refinance into your new loan amount.

When does rolling this expense into a new loan make sense? If you’re doing a cash-out refinance, your closing costs are generally included in your new loan. And when you don’t have the cash on hand to pay your closing costs, then financing them is likely an easy decision. But there are other times when it may benefit you to dig into the details before making your decision. Let’s start by discussing closing costs and where you can find the ones associated with your refinance.

Closing Costs and Your Loan Estimate

Closing costs are generally the expenses associated with refinancing your mortgage. These expenses might include charges for a home appraisal, credit report, title search, loan application, and loan origination. When you’re refinancing an existing mortgage, it’s common to see closing costs in a range from 2% to 6% of your loan amount. However, this can vary based on the size of your loan and if your lender offers any credits or discounts. For a list of the estimated closing costs associated with your refinance, look at the Loan Estimate form you received from your lender.

The Math Behind Financing Closing Costs

Now that you have an estimate of the closing costs you will pay, it’s time to do a little math. Why is that important? Looking at the numbers can help you understand your options. Let’s look at two calculations related to your monthly payment and opportunity costs.

Monthly Payment

When you make the decision to finance your closing costs, there will typically be an increase in the amount of your monthly mortgage payment. The exact amount of that change will depend on the details of your specific loan. In the loan scenario below, we’re using an estimated closing cost amount of $4,000 which is 2% of the loan amount.

In this example, there was an increase of $17 in the monthly payment amount when $4,000 in closing costs were financed at a fixed rate of 2.75% on a 30-year mortgage. Your lender can provide a comparison based on your specific loan details, or you can use an amortization calculator to determine the change.

Now that we’ve reviewed an example of the change in the monthly payment when you finance your closing costs, let’s take a look at opportunity costs.

Opportunity Costs

In a discussion about opportunity costs, people typically talk about the benefits that are missed when one option is chosen over another. When you pay your closing costs out of pocket, you are giving up an opportunity to use the money for something else. For example, the money could be used to make home repairs, pay off other debts, or save for a rainy day.

The following example illustrates the opportunity cost when using money to pay closing costs instead of credit card debt. Let’s use the same loan scenario as above along with the following information related to the credit card debt:

In this example, the opportunity to eliminate the credit card debt is lost when that $4,000 is used to pay the refinance closing costs up front. The financed closing costs are only $313.20 over 5 years. The credit card interest would be $2212.00 over that same period. The opportunity to potentially save $1,798.80 over a 5-year period is given up when the closing costs are paid instead of financed. To personalize the concept of opportunity costs to your unique situation, you may want to think about your existing debt, large purchases you want to make in the future, or other goals you may have.

Three More Considerations

When you are considering financing your closing costs, there are three more numbers that might influence your decision. In most cases, your lender will review these numbers with you when it comes time to finalize your loan.

Interest Rate