When structuring a mortgage home loan there are four ways to pay for the mortgage closing costs: pay cash at closing, roll the costs into the loan, increase the interest rate, or do a combination of the aforementioned methods. When lenders offer “no cost” loans or “low costs” loans they are either rolling the costs into the loan and/or rolling the costs into the interest rate.
How to Pay For Mortgage Closing Costs
There are technically three ways you can pay for closing costs. These methods can pay for all your Closing Costs and Prepaids. The only thing these cannot pay for is your down payment.
Combination Of All Three
You can use any combination of the three aforementioned methods to pay for your closing cost. For example, you can have a lender credit that covers some costs, the seller could pay for some costs via concessions, and you can then write a check for the remaining balance.
Pay Cash At Closing
Technically you can’t bring cash to closing; instead you need to bring a check, certified funds, do a wire transfer, etc. Watch our Closing video for the proper methods for paying costs at closing.[/toggle]
Roll Costs Into The Loan
For refinance home loans you can increase the loan amount (assuming there’s room in the LTV) to pay for the closing costs. For purchase home loans the Seller Concessions are used to “roll the cost into the loan.” With today’s interest rates the monthly payment changes by approximately $5 to $10 for every $1,000 that is rolled into the loan on a 30-year mortgage.
Shopping for a mortgage when purchasing or refinancing a home can be a complicated process. Borrowers want the lowest rate, the lowest costs, and a pain free experience – and who can blame them? However, contrary to popular belief taking the lowest interest rate may not always be the best option and could cost you money in the long run. When securing a home loan you may want to consider Premium Pricing.
There are three factors to compare when shopping for a home loan:
– Interest Rate
– Origination Fee
– Points and/or Lender Credits
Contrary to popular belief, putting the most emphasis on the interest rate may not be the cost-effective strategy. By taking a higher interest rate a lender credit may become available which reduces the Closing Costs for loan. This strategy is call “Premium Pricing.” For example, let’s say that instead of taking a rate of X on a mortgage someone took a rate of X + .25% which increased the P&I payment by $50 per month AND doing so provided them a lender credit of $4,200.
In this example the borrower won’t “feel” the higher rate for 7 years (4,200 credit / 50 per month = 84 months = 7 years) AND that 7 year break-even could be longer when considering the Mortgage Interest Tax Deduction. This means that if the borrowers anticipated selling, refinancing, or paying off the mortgage within a seven year time period then they should take the higher rate since the extra $50 per month won’t add up to the $4,200 in credit. In some cases, many folks just prefer keeping the $4,200 in their pocket at closing and aren’t concerned with the slightly higher payment regardless of how long they have the mortgage.
Seller Concessions are essentially a way to “roll-in” Closing Costs on a purchase home loan (see also How To Pay For Closing Costs). Seller Concessions are negotiated between the buyer and seller during the contract negotiations and are recorded in Section 12 of the purchase contract. (Note: Seller Concessions can be included in a contract amendment if there are re-negotiations after a home inspection). Seller concessions can pay for most costs associated with the purchase of a home with the exception of the down payment.
Example Of Seller Concessions
Joe Buyer likes Sally Sellers home that is listed for $300,000. Joe thinks he could Sally $297,000 for the home and Sally probably would accept the offer. Instead, Joe Buyer offers Sally Seller the full $300,000 for the home but request $3,000 in seller concessions. Sally accepts this offer because it’s the same bottom line net to her as a $297,000 offer with zero concessions, and Joe now reduces his cost to close by $3,000 (assuming the property will appraise for the $300,000).
Risks Of Seller Concessions
The major risk that exists in the aforementioned example is whether the house will appraise for the full sales price of $300,000. Let’s modify the aforementioned example to make a point. Let’s say that Sally Seller won’t budge on her $300,000 list price so Joe had to offer $303,000 to get the $3,000 in seller concessions. In this instance let’s assume that Sally had her home perfectly priced and the appraisal determines the value to be right at the $300,000. This presents a problem. Joe and Sally would now need to determine how to move forward – i.e. does the sales price get reduced to $300,000 with the $3,000 concessions included or does the price stay at $300,000 and the concessions removed?
Timing Of Concessions
Seller concession requests should be included at the onset of the contract negotiations. If seller concessions are added later in the process the buyer runs the risk of the appraisal already being completed and a value already determined based off the initial sales price. Plus, amending the contract after the fact may risk an appraiser and/or underwriter viewing the sales price as artificially inflated just to accommodate the concessions. (We realize this may seem “backwards” but trust us, negotiating the concessions up front removes these potential issues.)
Pros And Cons Of Seller Concession
The advantages to a buyer for having seller concessions is the reduction of funds due at closing. The seller concessions are effectively “rolling the costs into the loan” so that the buyer doesn’t have to write a check.
The disadvantages of seller concessions are that the monthly mortgage payment is increased as a result of “paying more” for the house. (Remember: if Joe Buyer is buying the home for $300,000 with $3,000 in concessions it means that he could buy the house for $297,000 with zero concessions). The good news is that the extra few bucks a month can be worth the trade off of saving thousands at closing. Example: an extra $3,000 financed on a 30 year loan at 5% is an extra $17 to $18 dollars per month (or about $5 to $6 per $1,000 financed). Feel free to play with our Payment Calculators to determine potential home loan payments.
Another disadvantage of seller concessions is that they may convey weakness to a seller and/or may the offer less competitive. If Joe Buyer is putting down a minimum amount for a down payment and is asking for seller concessions, it may lead Sally Seller to assume that Joe isn’t a very strong buyer. Moreover, if there are multiple contracts on a property then Sally Seller may be inclined to accept an offer without concessions as it may appear more aggressive.
Risk Of Too Much Seller Concessions
The other “risk” of concessions is a risk for the buyer when purchasing a home. If a buyer request too much in seller concessions then the buyer chances leaving money “on the table”. Let’s say Joe Buyer purchases Sally Seller’s house for $310,000 with $10,000 in seller concessions (and assume the house will appraise for $310,000). Let’s also assume that Joe Buyer only has $4,000 of total costs due at closing. The remaining $6,000 of concessions can’t go towards the down payment and Joe is not allowed to get money back which means Sally Seller would basically keep the extra $6,000. Make sure when negotiating concessions you know what to expect for costs at closing. Our Payment Calculators provide estimated closing costs for what to expect at closing.
Maximum Amount Of Seller Concessions
Every home loan program has a different amount that it will allow for seller concessions. Below are guidelines for the maximum amount of concessions allowed for various programs. Remember that the percentages are based off the purchase price and cannot go towards the down payment. Obviously you’re welcome to call us if you have any questions.
Seller Concessions For Conventional Home Loans
What are the maximum Seller Concessions or Contributions allowed on conventional and jumbo loans? The answer depends on what you plan to buy and how much you plan on putting down. Note: percentages are based off sales price and cannot go towards the down payment.
|Occupancy Type||Loan to Value (LTV)||Max Concessions|
|Primary Residence or Second Home||> 90%||3%|
|Primary Residence or Second Home||75.01% to 90%||6%|
|Primary Residence or Second Home||<=75%||9%|
|Investment Property||All LTVs||2%|
Seller Concessions For FHA Home Loans
The seller concessions for a FHA home loan is 6%. The seller concessions can pay for the Up Front MIP if desired.
Seller Concessions For VA Home Loans
The seller concessions for a VA home loan is 4%.
Seller Concessions For USDA Home Loans
The seller concessions for a USDA home loan is 6%.
Please feel free to call if you would like to discuss a specific scenario. As always we are here to help and discuss which option may be right for you.
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