When purchasing a home, borrowers are frequently asked if they would like to have the lender pay the origination fee or other closing costs by increasing the mortgage amount. Similarly, borrowers may be asked if they want to pay additional money to buy the interest rate down. This overview shows why most of the time, neither is the best choice.
To read the full whitepaper, click here: Bank Financing at Closing
Most people think that the lender is charging them the same rate to finance closing costs that they charge for the home loan. In reality, mortgage lenders may be charging as much as 18% interest on the funds used to pay closing costs. Borrowers can do much better simply by asking the Seller to pay the closing costs--then the lender doesn't charge a different interest rate on funds used to pay for things like origination fees, lender policy of title insurance, appraisal, and inspection fees.
Similarly, most borrowers who are considering buying down their interest rate should plan on staying in the property without refinancing for at least 10 years. Borrowers who refinance or sell prior to 10 years typically are making money for the lender. If you stay in the loan the full 30 years, you may get a great deal--but you have to stay the entire period of time.
Looking to determine if you should use lender paid closing costs or buy down your interest rate? Here is an calculator in Microsoft Excel that can help. Closing Cost and Buy Down Calculator.