Closing costs are arguably the bane of every home buyer’s existence. Closing costs are up-front fees that are typically due at the end of the mortgage transaction and must come out of a borrower’s pocket if they aren’t rolled into the cost of the loan. For first time home buyers (and even repeat home buyers), these fees are more than enough to make borrowers reconsider buying a home or refinancing an existing mortgage.
Whether a borrower handles all of their closing costs out of pocket, or manages to get many of them rolled into the loan itself, dealing with closing costs can still be a stressful process. For that exact reason, the threat of closing costs seems to scare many first time home buyers, who worry about not being able to cough up enough cash to actually close on the home they want.
While it may sound silly, being afraid of closing costs isn’t entirely irrational, either. Most conventional loans require a down payment of at least 20% in order for a borrower to qualify for a mortgage. With the average list price of a home in the United States at around $275,000, the average required down payment on a conventional loan comes out to a whopping $55,000. That amount doesn’t even take the closing costs into consideration, which could be anywhere from $5,500 to $13,750, or 2% to 5% of the purchase price of the home.
As you can see, even in the BEST case scenario for purchasing a home at the country’s average list price, the home buyer is on the hook for a smooth $60,500. While some home buyers are well aware of the possible expenses due at closing and save up ahead of time, there are still a staggering amount of people who are simply unable to save that kind of money. This is where seller contributions, sometimes called “seller concessions”, come in to play.
What are Seller Contributions?
A seller contribution is when the seller of property chips in to pay a portion of the closing costs, usually as an alternative to a lower purchase price. When home buyers make an offer on a home that is below the listed price, one option that a seller has is to offer to pay some of the fees due at closing as opposed to accepting the lower purchase price. Both parties stand to benefit from the arrangement, since the cash needed at closing is reduced for the home buyer, and the listed sale price remains intact for the seller.
What can Seller Contributions pay for?
While many home buyers aren’t aware that seller contributions are even an option, it goes without saying that plenty are unaware of what can be paid with them. For starters, they cannot be used towards a down payment. Seller contributions are solely designed to be used for the coverage of settlement fees relevant to the closing of the loan agreement.
The first thing of importance about seller contributions is that the allowances for a seller’s contribution varies by state, loan type, and even the purchase price of the home. Still, all things considered, sellers are typically allowed to contribute anywhere from 3% to 6% of the home’s purchase price towards the buyer’s closing costs. In many cases, even the lower 3% can cover all of the closing costs on a home loan.
In general, closing costs can range anywhere from 2% to 5% of the sale price of a home. These fees include (but are not limited to) home appraisal costs, lender origination fees, discount points, home inspection, escrow fees, title search fees, title insurance, up-front homeowner’s insurance and more. There always seem to be no shortage of added costs at closing, so having a way to avoid paying even a few of them can be greatly refreshing for any home buyer.
Can a seller Contribute more than the value of closing costs?
In short, no. Even with the caps in place, the actual rule of thumb is that the seller is only allowed to contribute the lesser of the sum of the closing costs or the seller contribution limit. This means that if the closing costs for a loan come out to $6,000, but the given cap for the loan type that buyers chose in conjunction with the sale price of the home technically allows a contribution of up to $10,000, the seller can only contribute a maximum of $6,000.
It’s important to remember this, as seller contributions are not intended to be used to assist the buyer with the down payment or reduce the borrower’s principal loan amount.
Advantages of Seller Contributions
There are a couple of reasons why seller concessions are beneficial-- and not just for the home buyer, either. Of course, having the seller take care of some of the costs of closing is a huge deal, but it isn’t just the home buyer reaping all of the benefits.
As the home seller, inputting contributions towards the buyer’s closing fees can help get the property sold faster. If a seller is in between selling their home and buying a new one, getting their home sold faster means being able to purchase a new home quicker. In addition, paying some of the closing fees might be a much cheaper alternative to having the listed price on the home negotiated down by the buyers. Home buyers may be more inclined to have to take out a larger loan amount if they know they won’t have to worry about paying expensive closing costs out of pocket.
Another awesome advantage for the seller is that some real estate brokers actually offer commission rebates to sellers when the home is sold. These rebates can offset the cost of seller contributions, making it an incredibly affordable option for getting a home sold. If you think about it, everyone benefits when a home purchase transaction is completed, so every little push counts for something!
Drawbacks of Seller Contributions
As a home buyer, the real drawback to seller contributions lies in the fact that they aren’t mandatory, but rather something that must be discussed and negotiated before closing. Not every seller is willing to pay anything for the home buyer, especially when they too are in the process of buying a new home. As a home buyer, it is in your best interest to not rely on seller contributions as a way of determining whether or not you can afford to get a home loan.
Additionally, even with generous contribution limits, sellers that are willing to make contributions typically have a dollar amount that they won’t dare go past. That means that choosing a loan based on the allowed limit for seller contributions is mostly a waste of time.
A clear drawback for home sellers is that no one wants to have to pay more fees just to sell their home. Closing costs can easily be in the thousands, and having to produce the funds out of pocket or have the proceeds from your home sale reduced is never fun.
Seller Contribution Limits by Loan Type
As we have mentioned earlier, the amount that a seller is allowed to contribute depends on a few factors. One such factor is the type of loan that the home buyer will use to purchase the home. There are a plethora of loan types for home buyers to choose from, each with their own rules as to home much of a seller contribution is acceptable.
Seller Contribution Limit for Conventional Loans
When it comes to buying a home, conventional loans are some of the most common loans on the market. Conventional loans are not insured by any government entity and are typically bound by whatever rules are set by the nation’s largest purchasers of mortgage loans, Fannie Mae and Freddie Mac. Rules for seller contributions are among those set by Fannie and Freddie.
According to the latest rules set by the mortgage giants, seller contributions for a primary residence are capped at 9% of the sale price of the home. Still, that figure is dependent on the down payment that the home buyer will be making. To break it down:
For a down payment of less than 10%, the seller contribution limit is capped at 3% of the sale price of the home.
For a down payment between 10% and 25% (the most common, with the average down payment being 20%), the seller contribution limit is capped at 6% of the sale price of the home.
For a down payment of 25% or more, the seller contribution limit is capped at 9% of the sale price of the home.
Seller Contribution Limit for FHA Loans
FHA loans are a hugely successful loan product among first time home buyers and are only gaining popularity as time goes by. Being a government insured loan program, they are well known for their highly flexible eligibility criteria as well as their low down payment requirements. In fact, eligible borrowers only need a 3.5% down payment in order to qualify for an FHA loan. They also have some benefits when it comes to seller contributions.
The Federal Housing Administration allows up to 6% in seller contributions to be put towards most closing costs, including discount points, and prepaid expenses. Additionally, If the property’s appraised value turns out to be less than the purchase price, the seller is allowed to contribute 6% of that value.
Seller Contribution Limit for USDA Loans
Typically focusing on home buyers in rural or low-income areas, the USDA’s home loan programs offer some incredible benefits for home buyers. In fact, some USDA loan products require zero down payment, and many boast incredibly low closing costs to begin with. Even so, the program still allows a seller’s contribution of up to 6% of the sale price of the home.
Seller Contribution Limit for VA Loans
VA loans are an incredibly amazing mortgage option for veterans, current members of the military, and military families. Some of the benefits include zero down payment requirements and limits on the amount a home buyer is expected to pay in closing costs. Those benefits alone are enough to boost even a first time home buyer’s confidence, yet they barely scratch the surface of how useful a VA loan truly is.
In regards to seller contributions, the VA does have some intricate rules. According to the VA, the seller may contribute up to 4% of the sale price of the home, as well as reasonable loan costs. The total contributions can surpass 4%, however, because the typical closing costs aren’t counted towards that total.
To clarify, VA guidelines specify that the 4% rule only applies to:
Discount points (exceeding 2% of the loan amount)
Payment of the mandatory VA funding fee
Compensation towards appliances or other builder-provided gifts
Payment of the home buyer’s debt obligations, fines, or judgments
For example, let’s say a home buyer’s closing costs towards items like home appraisal, loan origination fees, and title insurance equal 2% of the purchase price. The seller agrees to not only fund these closing costs, but also contributes towards prepaying taxes, insurance, the VA funding fee, and the repayment of a credit card balance all equal to 3% of the sales price.
The resulting 5% contribution would be accepted because 2% of the contribution is going towards actual closing costs that don’t fall under the limits of the 4% rule.
Using Seller Contributions for Upfront Fees associated with FHA, VA, and USDA Loans
While they may be largely beneficial for many home buyers because of their favorable loan terms, one downside to government-backed loans is the fact that they all need some form of funding fee. Luckily, they government-backed loans allow borrowers the option of prepaying these funding fees using seller contributions.
FHA Loans require a mandatory upfront mortgage insurance premium (UMIP) equal to 1.75% of the loan amount. This fee can be paid utilizing seller contributions, however, the contribution MUST cover the entire fee. In other words, if a home buyer intends to pay the UMIP using excess seller credit after other closing costs have been paid, but there isn’t enough credit left to cover the entire upfront fee, the use of seller contributions to cover the UMIP will not be allowed.
USDA typically require an upfront guarantee fee of 2% of the loan amount, that the home buyer is allowed to use seller contributions to pay.
VA loans may have some odd rules when it comes to seller contributions, but the seller is allowed to pay all or part of the upfront VA funding fee of 2.15% – 3.3% of the loan amount, as it falls within the VA’s 4% maximum contribution rule.
Alternatives to Seller Contributions
No matter what the amount, nearly every home buyer has a lot to gain from seller contributions. Getting rid of even a few of the costs associated with closing a home would be worth almost any hassle. However, finding a seller willing to pay the costs may be difficult, and is not always an option. If you need to purchase a home and are worried about how to afford closing costs, here are a few alternatives that may be worth keeping in mind.
A good portion of the time, sellers aren’t interested in paying anything for a complete stranger. That sort of financial aid is usually reserved for family. Which is why gift money is a such a big deal in regards to buying a home. If you weren’t already privy to the usage of gift money in a mortgage transaction, home buyers are generally allowed to be gifted money from a relative to use towards a down payment or closing costs on a home purchase.
There may be strict guidelines and meticulous documentation involved, but receiving gift money has helped many home buyers overcome the hurdle of affording to close a mortgage loan. And let’s face it, asking a family member for help sure beats asking a complete stranger whom you are purchasing a home from, doesn’t it?
Gift of Equity
Taking the idea of a gift from a relative one step further is the gift of equity. This is when you are buying a home from a family member at a price significantly lower than the appraised market value of the home. A gift of equity is not necessarily a way to dodge closing costs, but the resulting loan amount would be much more affordable for a first time home buyer. In addition, these sales can take place off of the public market, and can, therefore, bypass a good portion of the closing costs that come up with a typical home purchase.
Interested Party Contributions
Believe it or not, seller contributions are only a subsection of a much broader category known as Interested party contributions or IPCs. These contributions are used as incentives for a home buyer to purchase a particular home, or to ensure that the home purchase is seen through to completion. IPCs are bound to a specific dollar limit though, so you may want to check with your lender before accepting all of what may be offered.
Anyone who stands to benefit from the sale of the home is considered an interested party. This includes realtors, home builders, and definitely the seller. Sometimes, even grant programs for home buyers also fall within the interested party umbrella, so always be sure to discuss the options with your mortgage loan officer.
If your aim is to reduce the amount of cash due at closing, then one of the more popular options available to you is the FHA loan program. FHA loans are super easy to qualify for, and they only require a down payment of 3.5% of the sale price! When compared to the industry standard of 20%, choosing a FHA loan puts you at an advantage right out of the gate.
For retired or active members of the United States military, there may be no better option for reducing closing costs than with a VA home loan. VA home loans have a ZERO down payment requirement. That’s right, ZERO!
On top of that, there is actually a limit as to how much a home buyer can be charged in closing costs. Nothing but the best for the brave men and women who serve this great country!
USDA loans are specially designed for low-income areas and rural housing. There a few different loan options, but generally, USDA loans require low to zero down payments, since the target consumers may find it hard to make a down payment of 20%. The closing costs can also be rolled into the loan amount in some cases, making them even more affordable on the front end.
Seller Contributions: In Review
At this point, many home buyers and homeowners can agree: closing costs suck. Still, as a common part of the home buying process, they aren’t going away any time in the foreseeable future. That being said, not every home buyer gets stuck paying closing costs.
As a matter of fact, there are a few good options to reduce or even completely avoid closing costs. One such method is through seller contribution. Getting the seller to pay for all or even a portion of the closing costs may seem like a tall order, but it is actually surprisingly common.
Remember that sellers are often in the process of buying a home as well, and most of the time need the proceeds from their home sale to afford to buy their new home. If paying a portion of the closing costs means selling the home faster, then it isn’t that far fetched of an idea. As a home buyer, it never hurts to at least ask.
If you’d like to learn more about the ins and outs of seller contributions in a home sale, the home.loans team is only a call away. Don’t hesitate to reach out and speak with a mortgage expert today!!