Is it a good idea to include your closing costs in your mortgage, or should you pay them separately? Today, we’re going to cover a topic that is on everyone’s mind, because everyone is looking to take advantage of the rates and, basically, apply for a mortgage to either refinance or to continue to expand their real estate portfolio.
Is it a good idea to save your cash and just include those closing costs in your mortgage? It depends! And that’s the beauty of real estate. It is versatile. Real Estate allows you to, basically, be creative and take into account your circumstances and see what’s the best strategy for you.
If you’re new to real estate, and you’ve never heard about the term closing costs, here’s a link to learn more about it.
Down payment + Closing costs
When you buy a house, the first thing you need to do is to come up with the down payment. The thing about down payments is that the money you pay towards that is going to go towards the equity of your house.
For example: you found a great house for investment, and the asking price is $200,000. The bank says, “Yes, we’re going to help you finance it as long as you put down 20%.” 20% of $200,000, that’s $40,000.
That means that when you put down $40,000, the bank is going to help you finance the remaining $160,000. This becomes your mortgage, and $40,000 is the capital that belongs to you.
Now, let’s say you go through all the necessary steps to get a mortgage created:
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You go through your appraisal, and then you make it all the way up to the end, and now you have closing cost. Closing costs are somewhere around 3% to 5% of the purchase price. To find the middle ground, let’s go with 4%; so 4% of 200,000, that’s $8,000.
In the end, the key question is: Should you pay that amount ($8000) separately or should you pay it as part of your mortgage? If you’re including that as part of your mortgage, what you’re financing won’t be just $160,000. What you’re financing at the end is $168,000. That means, you’re going to pay interest on the $168.000 amount, because you’re now including the closing cost in the mortgage.
Should you do that in the end? The answer will depend on a couple of factors. The best scenario to closing costs as part of your mortgage is when you’re buying an investment property. Why? Because of the United States tax code.
US Tax Code: Tax Deductions
When you’re investing in a rental investment, not for you to live, but to make money off of it and create cash flow, you’re running your real estate portfolio as a business. You put your property into an LLC. An investment property that runs like a business will get you a lot of tax advantages.
For example, let’s say you generate $20,000 worth of rent. Your mortgage plus closing cost ends up costing you about $8,000 in interest (annually). In the end, that will leave you with $12,000.
Uncle Sam is giving you a break, because you generated $20,000, but you also have to pay $8,000. You’re creating jobs, and you’re helping the banks create jobs as well. Instead of taxing you on the $20,000, they’re going to tax you on $12,000. That’s a nice deal.
The second reason why you will want to include your closing costs into your mortgage is if you don’t have any cash, you don’t have any liquidity, no money left. If you decide to incorporate all of those closing costs into the mortgage, you will be able to take advantage of the deductions.
Don’t do it when…
Moving on to when it is not a good idea to include the closing cost as part of your mortgage. It is not a good idea when you’re buying your primary residence. Why? When you’re investing in an investment property, you’re not the one paying your mortgage or the interest. Your tenant is.
You are collecting money, because you’re running a business. Whatever you get from that rent, is what you’re going to utilize to pay for that debt. That money is not necessarily coming out of your pocket.
But when you’re buying your primary residence, the principal pay down is coming out of your pocket. Also, the interest on that mortgage and the closing costs are also coming out of your pocket.
You definitely do not want to pay extra on that. In addition to that, you don’t get the same deduction that you would normally receive in your investment portfolio.
The second reason why you should not include the closing costs in your mortgage is if you have the cash available. Why? Because you’re trying to save money on interest rates. If you have the liquidity available, why not just pay that, and just get it over with?
We hope that by now you have more information to help you make a decision based on facts. Happy investing!
