When you purchase a home, you must pay closing costs, which are the fees the lender charges to recoup loan processing costs. These can add up to a hefty sum, typically 3% to 6% of your mortgage amount.
Typically, you can take out a personal loan to cover those closing costs and help you across the finish line of a property purchase. You can often tap other funding sources as well. Take a closer look at the pros and cons of using a personal loan for closing costs, plus the alternatives, so you can decide what’s best for your needs.
What Are Closing Costs?
Closing costs are processing fees that you pay to your lender, either as the buyer or seller in a real estate transaction:
• Buyers: Buyers typically pay between 3% and 6% of the total loan amount in closing costs. Buyers must pay this amount out of pocket, so it’s important for them to have a plan for how they’ll access the money before they get to the closing table.
• Sellers: If sellers contribute to closing costs (say, to negotiate a home sale), those fees usually get taken out from the sale proceeds.
Here’s an example: If you plan to buy a home with a $300,000 loan, as the buyer, you’ll need to bring between $9,000 and $18,000 to the closing table. If you were the seller, you’d see that amount taken out of the costs you’d pocket from the sale.
Fees Associated with Closing Costs
Closing cost fees may include:
• Application fee: Lenders sometimes charge a one-time fee for borrowers to submit a loan application.
• Credit report fee: A credit report or credit check fee covers the cost to dig into your credit report, which shows your credit history. Your lender uses the information it uncovers to decide whether to approve your loan and how much they’ll lend you.
• Origination fee: You pay this fee to the lender to process the loan application.
• Appraisal fee: A fee paid to a professional to appraise the home based on an evaluation to determine its fair market value.
• Title search: A title search looks into public records to determine who actually owns the property and who has liens on the property (for example, an unpaid contractor’s lien for work done on the home).
• Title insurance: Title insurance protects you from financial loss and legal expenses in case the home has a bad title.
• Underwriting fee: Underwriting is the process of reviewing your finances to determine the risk of offering you a mortgage, and the fees cover this process.
• Property survey fee: Property survey fees cover the cost of checking the boundaries and easements of a property. This process shows exactly where the property’s perimeter is and what the property includes.
• Attorney fee: You will probably need to hire a lawyer to review the terms in your purchase contract and handle your closing.
• Discount points: Discount points are a way to balance your upfront costs and your monthly payment. If you use points to pay more upfront, you’ll likely have a lower interest rate, meaning that you could pay less monthly and over your loan term.
• Homeowners insurance premiums: Homeowners insurance provides financial protection if your home undergoes a disaster or accident. You must typically show your lender that you have paid homeowners insurance.
• Mortgage insurance: If you have a down payment of less than 20%, you will often have to pay mortgage insurance, a fee per month that protects your lender if you were to default. You’ll also have to pay a version of mortgage insurance on Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans. You may have to pay these insurance fees with your closing costs in addition to your monthly payments, particularly for the FHA and USDA loans.
• Property tax: Homeowners pay property tax to state, county, and local authorities for schools, roads, and other municipal services. You may have to pay a portion of your property tax at closing.
• Homeowners association (HOA) fees: If you plan to move to a neighborhood that has an HOA, or an organization that makes and enforces rules for a neighborhood, you may owe HOA fees at closing. The seller may pay these on a prorated basis.
• Per-diem interest: Per-diem interest refers to the interest a lender charges for the days between a closing date and the first day of your billing period.
• Transfer tax: State or local governments often charge real estate transfer taxes, meaning that they charge when properties transfer ownership.
• Recording fee: State and local governments charge recording fees to legally record your deed, mortgage, and other home loan documents.
Note that this isn’t an exhaustive list of closing costs — you may be on the hook for other fees as well.
Can You Use a Personal Loan for Closing Costs?
First, it’s important to understand how a personal loan works. It is usually funded by a bank, credit union, or online lender. You can typically use the money however you want — there aren’t as many restrictions on personal loans compared to, say, student loans. After you receive a personal loan, you pay it back with regular, fixed payments (with interest) over a specified term.
As mentioned above, you can use the cash as you see fit. So, yes, you can use a personal loan for closing costs. However, you can’t use it for a down payment, and you must tell your lender that you’ll go this route and borrow to pay the closing costs. The lender will include it in your debt-to-income (DTI) ratio, which is the amount of debt you have relative to your income.
Applying for a personal loan can involve prequalifying with several lenders and comparing them, gathering required documents (ID, proof of address and income, Social Security number, and education history), filling out the loan application, and receiving your funds after approval. You may be able to get a personal loan in one to three days.
As you shop around for funds, you’ll likely want to consider what credit score you need for a personal loan at a given interest rate. Also consider the length of the loan term; this can typically range from one to seven years.
Recommended: Guide to Personal Loans
Pros of Taking Out a Personal Loan for Closing Costs
Here are some of the key benefits of taking out a personal loan for closing costs.
• Collateral not required: Personal loans are often unsecured loans, meaning that you don’t have to put an asset up in order to receive the loan. Therefore, if you fail to repay the loan, your lender will not claim the asset to repay your debts.
• Quick approval: It usually doesn’t take long to get a personal loan once you’ve been approved. After you submit your application and materials, it might take just a day to get the personal loan, though it could take longer.
• Flexible repayment options: You can tap into flexible repayment plans, including no prepayment penalty, meaning that the lender won’t penalize you for paying off the loan early.
Cons of Taking Out a Personal Loan for Closing Costs
Next, consider the downsides of using a personal loan to cover closing costs.
• DTI increase: Lenders will look at your overall debt under a microscope, so taking on a personal loan may factor into your overall debt. It may signal to the lender that you aren’t in a good financial position since an additional loan could raise your DTI ratio. It might keep you from being approved for a mortgage or could result in a higher mortgage interest rate.
• Additional loan payment: You might find it tricky to repay a personal loan in addition to a mortgage payment. Consider whether you can comfortably make both payments every month.
• High interest rates: There is the potential for high interest rates if you have poor credit. This can make it more challenging to afford a personal loan.
Recommended: Personal Loan Requirements
Alternatives to a Personal Loan for Closing Costs
You may have options vs. getting a personal loan for closing costs. Consider how else you might handle those fees.
• Roll them into your mortgage: You may be able to add your closing costs to your mortgage, but this means you’ll increase the principal balance of your loan. This will increase both the principal and the interest you’ll pay over your loan term and also translates to higher monthly payments.
• Ask for a waiver: Your lender may be willing to waive certain fees. For example, they may reduce certain processing fees. There’s no guarantee, but it can be worth asking. That might help you out with your final closing cost amount.
• Ask the seller to pay: As mentioned previously, sellers may pay for some of the closing costs if they’re eager to ensure that the property sale doesn’t fall through.
• Tap into assistance programs: Many state and local governments offer down payment and closing cost assistance programs for moderate- to low-income home buyers. Look into your state’s housing finance agency, your city or county website, the U.S. Department of Housing and Urban Development (HUD), or check with your lender to learn more about your options.
• Use gift money: Do you have a generous grandparent or parent who wants to help you cover your closing costs? Your state may have rules and regulations attached with gift money (especially ensuring that it’s an actual gift). Check with your lender to learn more.
The Takeaway
You can typically use a personal loan to pay for closing costs, the fees that can cost 3% to 6% of your home loan amount when you purchase a property. While this can be a convenient source of funding that is typically unsecured (meaning no collateral is required), it can raise your DTI and add to your monthly financial burden. It’s wise to carefully consider all the pros and cons, as well as alternative funding sources, when deciding whether to use a personal loan for closing costs.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
Is it smart to finance closing costs?
Whether it’s smart to finance closing costs depends on your personal situation. For example, for some people who can handle the additional monthly payment, it may be a convenient move. On the other hand, getting a personal loan may increase your DTI, so your mortgage lender might charge you a higher interest rate or deny you the loan altogether.
Can I put closing costs on a credit card?
While you’ll usually use a cashier’s check, certified check, or wire transfer to pay for closing costs, you can put some closing costs on a credit card, such as attorney, appraisal, and survey fees. Check with your lender to learn more about which fees you can put on a credit card. (Also note that using your credit card in this way can raise your credit utilization rate and potentially lower your credit score.)
What is not an acceptable source of funds for closing?
Closing costs are typically paid by a cashier’s or certified check or by wire transfer. Funds for these could be acquired by such sources as a government program or a personal loan. Less frequently, credit cards, debit cards, and personal checks may be accepted for some closing costs.
Photo credit: iStock/jacoblund
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