Seller Paid Closing Costs: Knowledge is Power

When you’re considering making an offer on a home, there are other ways to get a good deal other than just snagging the lowest price you can imagine.  Most loan programs allow the seller to concede money toward the buyer’s closing costs that would normally walk away with the seller in his pocket.  Oftentimes, seller paid closing costs can make a home more affordable for you.  You just have to make sure you stay within the allowable guidelines for the mortgage product you need.

You see, a lot depends on what type of loan you are getting.  The scenarios I am going to discuss all pertain to if you are buying your primary residence, not an investment or second home.  And the reason the amount that a seller can pay on your behalf varies from product to product is because different loan types have different documentation requirements, and therefore, different layering of risks.  So, it’s important to compare apples to apples.  The less money out of your pocket invested into your home presents a higher risk for the lender, regardless of the source of the funds to close.

For instance, I had a loan the other day where the seller had agreed to pay up to 6% of the sales price in closing costs on behalf of the borrower.  Totally reasonable since the borrower was getting an FHA loan.  Unfortunately, the home wasn’t up to FHA standards, and the loan had to switch to Conventional financing.  Whoops.  Conventional financing only allows for 3% seller concessions if one is putting less than 10% of the sales price down on the property.  All of a sudden the negotiated contract wasn’t working out to the benefit of the borrower quite as nicely.  She actually would be paying more for the property than she need be without the same benefit to her unless she re-negotiated a lower sales price.  Why is that?  Well, originally the sales price was $100,000.  The seller was giving her $6,000 toward closing costs and walking away with $94,000 in his pocket.  Now, Conventional underwriting guidelines would only allow him to give the buyer $3,000.  So his pockets would be a bit fuller unless the buyer renegotiated.

Different loan programs have different allowable amounts for seller concessions.  For instance, VA loans allow the seller to pay 4% of closing costs, and Rural Housing loans have no limit on seller paid closing costs.  Conventional loans will allow up to 6% seller paids, but the buyer has to put more than 10% money down on the property.  And finally, FHA allows for 6% of sales price paid on behalf of the buyer toward closing costs. 

Don’t lose sight of the fact that seller paid closing costs usually don’t count toward a buyer’s minimum out of pocket investment required.  For conventional and FHA, you usually have to come up with at least 3% of your own funds regardless of how much the seller is willing to help out.  VA loans and Rural Home loans allow for 100% financing in most cases, so you’re good to go there.  And FHA will allow the seller to participate in a down payment assistance program and contribute toward your 3% investment, but that’s a whole other article to write (and who knows if it will still be ok by the time this article makes it to print).

Your best rule of thumb is to work with a lender and realtor who know what they are doing.  And if you have any doubts, your lender should be able to define your limitations for you pretty quickly.  So, arm yourself with knowledge when negotiating your contract.  It is always to your advantage to negotiate from a position of strength, and knowledge is power in this case.