Understanding Seller Credits To Closing Costs
A Seller Credit to a Borrower’s Closing Costs is a common way (especially with first-time home buyers) to reduce that total amount of money it will take for a borrower to complete a home purchase transaction. Seller Credits to Borrower Closing Costs are also referred to as: sales concessions, seller paid costs, or seller contributions. Whatever term is used, a seller credit can be a very effective way to get a buyer into a home in cases where there are limited available funds or a buyer is tight on the total funds needed for the transaction.
Home Buyers need to account for the following costs when purchasing a home:
Down Payment
Closing Costs & Prepaid Items (Ie. lender fees, appraisal and inspection, taxes, title/attorney fees, and Insurance Premiums paid in advance)
Post Closing Reserves Required By The Lender (If Applicable)
Depending on the purchase price, state and loan type, Closing Costs and Prepaid Items can range anywhere from 2% - 5% of the home’s contract price. Home Buyers with limited funds can utilize a “Seller Credit” to help significantly reduce their out-of-pocket costs and enable them to purchase a property they would be otherwise unable to.
What Situations Can A Seller Credit To A Home Buyer’s Closing Costs Be Helpful?
Seller Credits are effective for cash-flow challenged buyers. Structuring an offer with a Seller Credit is helpful in a number of situations, including:
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The home buyer is struggling to meet minimum down-payment requirements, closing costs, or lender reserve requirements.
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The home buyer wants to make a 20% down-payment to avoid mortgage insurance, but is slightly short of this amount because of closing costs or reserve requirements.
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Home improvements or repairs are needed & the home buyer needs to maximize post-closing liquidity in order to complete these projects.
Why Would A Seller Agree To Give A Credit To Closing Costs?
Providing a seller credit is an incentive a seller can use to help sell their home more quickly. The longer a property stays on the market, the more costly it becomes for the seller. Carrying costs such as mortgage interest, taxes, HOA dues, pressure to meet their own deadlines (ie. the seller is using proceeds to purchase another property), and risk of the listing becoming stale are considerations a seller may take into account in deciding accept an offer from a buyer with a seller credit.
Additionally, it is common for the purchase price to be negotiated around a seller credit. In some cases the buyer and seller will agree to increase the purchase price to offset the cost to the seller of a seller credit to the buyer’s closing costs. As long as the property will appraise, this can be an effective way for a buyer to receive a seller credit and reduce their overall transaction costs.
For Example:
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Purchase Price = $200,000 |
Purchase Price = $205,000 |
|
3.5% Down Payment = $7,000 |
3.5% Down Payment = $7,175 |
|
Closing Costs & Prepaids = $5,000 |
Closing Costs & Prepaids = $5,000 |
|
Seller Credit To Closing Costs = $0 |
Seller Credit To Closing Costs = $5,000 |
|
Total Out Of Pocket Costs for Borrower = $12,000 |
Total Out Of Pocket Costs for Borrower = $7,175 |
|
Net Savings In Cash For Borrower = $4,825 |
|
In the example above, by increasing the purchase price by $5,000, and having the seller give the home buyer a credit to the closing costs, the buyer’s cash-to-close is reduced by $4,825 while the seller nets the same amount of money. The key for this to work depends on what the property will appraise for. Buyer’s will want to consult with their realtor to determine the likelihood of the property appraising.
Lender’s always base they amount of money they will lend on the lower of the appraised value or purchase price. If the property appraises, increasing the purchase price as demonstrated above will work, if the property does not appraise, then the buyer would need to bring the difference between the appraised value and purchase price to closing.
What are the Maximum Seller Paid Costs For Conventional, FHA, VA & USDA Loans?
Each loan type has slightly different rules when it comes to seller contributions. Below is a chart detailing the rules regarding the maximum Seller Credits permitted for different types of loan types. Remember though that regardless of the chart below, a Seller Credit can never exceed the total amount of buyer closing costs and prepaid items.
Conventional Loans Max Seller Contribution
|
Occupancy Type |
Down Payment |
Maximum Seller Credit |
|---|---|---|
|
Primary Residence Or Second Home |
Less Than 10% |
3% |
|
10% - 25% |
6% |
|
|
Greater Than 20% |
9% |
|
|
Investment Property |
Any Down Payment Amt |
2% |
FHA Loans Max Seller Contribution
For FHA Loans the maximum amount of Seller and other interested party credits cannot exceed 6% of the sales price.
VA Loans Max Seller Contribution
For VA Loans the maximum amount of Seller Contributions cannot exceed 4% of the sales price in addition to normal discount points and traditional seller credits to borrower closing costs.
According to VA guidelines, the 4% rule applies to the following items a seller is allowed to pay for a buyer on top of traditional closing costs:
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Prepayment of property taxes and insurance
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Appliances and other gifts from a builder
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Discount points above 2% of the loan amount
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Payoff of a buyer’s judgments and debts
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Payment of the VA funding fee
For Example: A buyer’s closing costs for items such as appraisal, taxes, title ins, and recording fees equal 2% of the purchase price. The seller agrees to also prepay the cost of the buyer’s property taxes & homeowner’s insurance, the VA funding fee, and a credit card balance totaling 3% of the sales price. The total contribution would be 5% and is allowable because 2% is going towards actual closing costs and only 3% is going towards concession items (less than the 4% max).
USDA Loans Max Seller Contribution
For USDA Loans the maximum amount of Seller Contributions cannot exceed 6% of the sales price.
Can a Buyer Receive a Seller Credit For More Than The Total Closing Costs & Prepaid Items?
No. A Seller Credit to Buyer Closing Costs cannot exceed the total amount of the actual closing costs and prepaid items. For Example: A home buyer’s closing costs total $5,000 and the seller has agreed to credit $10,000. In this situation, the borrower would only be able to use $5,000 of the seller credit. The remaining $5,000 would be lost.
What Do I Do If My Seller Credit Exceeds My Closing Costs & Prepaids?
If your seller credit exceeds the total of your closing costs and prepaid items, you can constructively increase your total closing costs to make use of any extra seller credit buy paying “points” to buy a lower interest rate from your lender. For Example: You are buying a home for $250,000 and are making a $50,000 down payment and will be receiving a $200,000 loan. The seller has agreed to give you a 3% credit to your closing costs ($7,500), but your closing costs total only $5,500. You don’t want to lose the extra $2,000 that the seller has agreed to credit you at closing. In this case you could approach your lender and ask them to give you a lower interest rate. In this particular case you have $2,000, which equals 1% of the loan amount of $200,000. After speaking with your lender they agree to give you a .25% better interest rate for paying 1% discount point at closing. Since this discount point is part of your total closing costs, you are able to apply the seller credit to it.
Can I Use a Seller Credit to Pay for Upfront FHA, VA, and USDA Fees?
FHA, VA, and USDA loans have Upfront Funding Fees. Each program permits Seller Credits to be applied to their upfront fees.
- FHA Upfront MI = 1.75% of the loan amount
- VA Upfront Funding Fee = 1.25% - 3.3% of the loan amount
- USDA Upfront Guarantee Fee = 2% of the loan amount
FHA
FHA allows Seller Credits to be applied to FHA Upfront MI, but to do so the entire fee must be paid by the seller. FHA does not permit partial payments of FHA Upfront MI.
VA
The VA allows Seller Credits to part or all of the upfront funding fee. This fee counts towards the 4% max seller contribution.
USDA
A Seller Credit can be used to pay for the USDA Upfront Guarantee Fee.
Can you Increase the Contract Sales Price to Include a Seller Credit To Closing Costs?
Yes. As described above, a buyer and seller may negotiate a higher purchase price on a property in order to include a seller credit to the home buyer’s closing costs. Increasing the purchase price, can potentially lead to an appraisal issue. If the appraised value comes in lower than the contracted purchase price, the buyer will need to bring the difference to closing, which would increase the total cash-to-close and defeat the purpose of including a seller contribution to closing costs to begin with.
It is highly recommended that you include a realtor or attorney when negotiating these details to determine the likelihood of the property appraising at the higher purchase price and to protect yourself in the event the property does appraise lower than anticipated to make sure you have protections/contingencies to cancel the contract if necessary.
