If you’re in the housing market for the first time, the mounting cost of everything can get pretty overwhelming, even if you’ve been saving carefully. After all, everybody knows to save five to 10 percent of our dream home’s cost for a down payment, but fewer people know that we need to be saving another similarly-sized fortune to cover our closing costs.
All these financial pains are almost enough to make any home buyer throw up their hands in frustration. After all, the economy’s still recovering and you’ve got student loans, car payments and children to support — where are you going to find so much extra money? Luckily, there’s a way around plopping down even more of your hard-earned cash than necessary on the closing table — you simply have to ask your future home’s seller to pay these fees for you.
I know it sounds overly simplified, but it really is that easy. As to why a seller would be willing to do this for you, there are a number of common reasons. One of the biggest is that someone else did it for them. Others sellers might believe they won’t find another buyer and will do what they must to move their home.
Whatever the reason, seller’s concessions aren’t simply a generous gift. They’re another piece in the complicated real estate puzzle you’re just now finding yourself working.
What are Seller’s Concessions?
A seller’s concession is an amount of money paid toward closing on your behalf. Generally, this money is used to pay for closing costs, but sellers occasionally concede money if they realize their carpets are gross and need to be replaced or that their garage needs repairs they don’t really want to make.
In most cases, the seller’s concessions may look like a gift, but they’re really just a legal way to allow you to roll the closing costs of your transaction into your loan. Don’t expect it to be simple, though. No matter what you’ve got to offer, the sellers have already decided on a final cash price they need from their home, so they’ll counter your offer with seller concessions until a final deal has been reached that gets them to their magic number. Sometimes, that’s going to drive your contract amount over the sales price, but as long as the home will appraise, it’s fine.
The amount a seller can contribute varies widely between loan products. In general, a conventional loan allows anywhere from two to nine percent of your new home’s sales price in seller concessions, a VA up to four and FHA and USDA loans allow six percent in seller concessions. For buyers who are cash poor, this is great news because it means they’ll still be able to buy. If sellers weren’t allowed to give this money to buyers on paper, it would have long-reaching effects on the real estate market.
Which Fees Can Seller’s Pay?
In practice, sellers can basically pay any of your settlement costs. The only thing most loan programs prohibit is the seller contributing to your down payment (and most banks will want you to pay for your own application or credit check fee). There’s a catch, though. If you want the seller to pay these items for you, you’ve got to get it in writing up front. This is where a strong Good Faith Estimate comes in.
Once you’ve got a pre-approval, you’ll have a good idea what your closing costs will be and what loan program you’ll be using. These are the two big pieces of information you’ll need to nail this low cash closing tactic. Some Realtors will go the easy route and ask the seller to pay up to three, four or six percent (depending on your loan program) in closing costs, prepaids and other fees on your behalf, but if you live in a low tax area and are purchasing a modest home, you may be leaving money sitting on the table.
What I mean is that if your closing costs are only actually going to be something in the neighborhood of four percent and you ask the seller for six percent, you’ve just given a whopping two percent of your purchase price to the sellers. That’s a generous tip for the benefit of signing one document — so it’s best practice to try to get close to the actual price of closing costs and expect to bring a few hundred extra dollars to the table instead.
Let me show you how it works. In 2014, the average home sale in the midwestern United States (a notoriously low-tax area) was $196,700. Let’s say that’s the house you bought — and you asked for six percent in closing costs but only needed four percent. Six percent, the amount you asked the seller to pay, is a whopping $11,802. Four percent, on the other hand, is only $7,868. So, if your closing costs were actually around $7,900 and you asked for six percent, or $11,802, you just gave the sellers an extra $3,902 — that’s a hefty chunk.
|Conventional Without Concessions||Conventional w/Concessions||FHA w/Concessions|
|Seller Concession Percentage||0%||3%||6%|
|Seller Concession Amount||$0||$6,000||$12,000|
|Loan Type||30 Year Fixed||30 Year Fixed||30 Year Fixed|
|Cost of Concessions||$0||$28.65||$57.29|
Comparing Costs of Seller’s Concessions Across Loan Types with 5% Down Payment
Why This Works
A seller’s concession works because you voluntarily raise the sales price of your future home to cover whatever amount you’ve asked the seller to pay. So a $200,000 house becomes a $212,000 home on paper if you need six percent, or just a $208,000 house if you need four percent. It’s illegal in most states for a seller to give you money directly (this is called an inducement), so they can’t actually pay your closing costs — this is the only way they can help you.
The artificially inflated sales price we established above (your home still has to appraise, so don’t get crazy) still goes directly into the home seller’s pocket. Every last nickel. When the nice people at your settlement company draft up the HUD-1 that explains where all the funds are coming from and going to, you’ll find a credit on your bill that comes directly out of the seller’s profits. That’s the seller’s concession — their legal gift to you in the form of your closing costs.
These costs can be capped by loan program rules, state law and even internal bank requirements, so they may vary slightly from what you expected, but they should come close to your Good Faith Estimate. If you have a pre-approval before you make an offer on any home, you’ll have a much clearer idea of costs than if you just had your Realtor estimate those costs for you.
The Bottom Line: Are Seller Concessions Worth It?
Whether or not using seller concessions are worth it is a difficult question to answer, in all honesty. I think a buyer looking to stay in a home for the long haul, in the current market, at current market rates will be ok. Buyers looking for a short term solution will never fare well with this situation, regardless of rates. Yes, you wannabe flippers, you can ask for seller concessions, too — but keep in mind that institutions are much less likely to agree to any kind of terms than individual owners.
The fear of seller concessions is an old one, and I honestly think it goes back to the 1980s, when low down loans were new and rates were frighteningly high. Because you’re adding anywhere from three to six percent to your loan on top of the purchase price of your home, if you’re not bringing much to closing, you risk being at a zero equity position right away.
When rates are high, the mental strain of that high amount of interest you’re going to pay in the first five to ten years can be a killer. Adding anything extra to it, like an additional chunk of interest on your seller-paid closing costs, can make the whole concept overwhelming. The origin of the anti-Seller Concession mentality was a world where you’re financing an extra six percent on top of a loan that’s got a 15 percent interest rate. You can see where this was all kinds of wrong, and, at one point, it made for a loan you’d spend half your life trying to escape.
But that’s not the world we’re in — rates are still crazy low and the market, while stable, is not what it once was. Buyers are expected to stay in their homes an average of 13 years now and that’s plenty of time to pay down that little extra you’ve borrowed to cover your closing costs when we’re talking about a meager four to five percent interest mortgage.
Between low interest rates and the hope that values will continue to sneak up a little more in the next decade and then some, I would heartily recommend using seller concessions when you can, provided you do it smartly. By taking advantage of this special tool, you’ll be able to keep more cash in your pocket that you might need for updates or unexpected repairs.
Sure, you’ll pay a few extra dollars a month for the privilege, but it will only be a few dollars a month — and that free cash might be hard to find again once you let it fly. I’ve always believed in putting as little as possible on the table at closing time, because anything and everything can go wrong in a house at the most inopportune times. One leaky roof, one bad air conditioner and you’ve got a massive bill you’ve got to cover and fast. Let the seller help you out, take advantage of seller concessions.