Closing Costs and Closing Cost Credits Explained

How Do Closing Cost Credits Work

In real estate, there are specific terms you should understand well. Two such terms are closing costs and closing cost credits.

If you are selling a home, there is a good chance that you will encounter a buyer that requests you to pay part of their closing costs.

It’s often called a closing cost credit or seller credit.

Your immediate reaction may be irritation. Why, after all, should you pay for the closing costs? But it is essential to understand that a closing cost credit doesn’t necessarily mean that you are losing money or paying the buyer for buying your home.

It’s just a way for the buyer to have more cash on hand for initial repairs and other necessities after buying. It could also be for just that – the actual closing costs.

Understanding how closing cost credits work and how they affect your home sale is necessary for today’s real estate market.

Knowing the purpose of closing costs will help you navigate the process of selling your home a little more comfortably and will allow you to get on with selling your property.

So if there is a request for closing cost credits in an offer for your home, don’t freak out! Remember that the only important thing is what you are netting on the property. The sole focus should be your bottom line.

One other thing worth mentioning is that closing cost credits are also referred to as “seller’s concessions.”

Keep reading to see what’s the purpose of a closing cost credit!

What is a Closing Cost?

In order to understand closing cost credits, you should first have an understanding of what are closing costs. Real Estate agents get asked all the time what is a closing cost. A closing cost is a fee paid during buying or selling a home.

Both buyers and sellers have closing costs. Let’s have a comprehensive look at the closings costs a buyer will pay during a real estate transaction.

One of the things most home buyers will look to do is figure out how to pay closing costs. As you’ll find out, a closing cost credit from a seller is a popular method.

Examples of Closing Costs

Loan Application Fee

There could be a one-time fee a buyer pays to get a mortgage loan with a loan application. Some lenders, however, do not charge an application with a home loan.

Origination Fees

Loan origination fees are costs charged by a mortgage lender to process a home loan. These fees typically amount to .5% and 1% of the total loan amount.

Discount Points

A discount point is a fee you pay upfront to get a lower mortgage interest rate. Without paying points, you will typically have a higher interest rate. It is also possible the financial institution you’re working with could offer lender credits.

A closing cost credit from a lender is not uncommon at all.

A lender credit works similarly to discount points but in reverse. The mortgage lender gives you money to pay for closing costs, but you’re charged a higher interest rate.

With lender credits, you’ll pay fewer fees upfront but will pay more over the loan length with a higher interest rate.

You will usually have a higher monthly payment when receiving lender credits.

Appraisal Fee

When getting a mortgage, the lender will have the home appraised by a licensed appraiser to ensure the home’s purchase price is acceptable.

The home appraisal will determine if there is an appropriate amount of equity in the property.

Escrow Fee

In some parts of the country, the will be an escrow fee for a title company to hold your earnest money in an escrow account. It also could be controlled by an escrow company. Escrow fees commonly range between 1%-2% of the home’s purchase price.

Attorney Fees

An attorney fee will be charged by the lender giving you the mortgage. The fee covers the lender’s attorney and is part of your closing costs.

You could also pay a separate real estate attorney to look over the home purchase agreement and attend the closing. An attorney’s fee can vary depending on where you’re located and the amount of work involved. Expect to pay somewhere between $300-$1000.

Private Mortgage Insurance

Depending on the loan type and the down payment amount, it’s likely you’ll be paying private mortgage insurance or PMI for short.

If you are using a conventional loan, you’ll pay PMI when you have less than a 20 percent down payment. Government loans work differently.

With VA loans, you avoid paying PMI. FHA loans do not have private mortgage insurance either.

They do, however, have an upfront fee called a Mortgage Insurance Premium and a mortgage insurance premium (MIP) to be paid instead.

USDA loans do not have private mortgage insurance. First-time home buyers should look over the mortgage programs available to them.

Pre-Paid Property Taxes

Another closing cost you can expect to pay is pre-paid property taxes when buying a home. There are no escaping property taxes, and you’ll be required to pay your fair share.

In most places, sellers are the ones who pay transfer taxes, so buyers usually avoid this upfront fee.

Homeowners Insurance

Mortgage lenders will often require borrowers to prepay their homeowner’s insurance policy upfront. The cost of insurance for a house will vary depending on a few factors, including the amount of coverage, the size of the home, and the area you’re located.

One of the mortgage questions I like to find out from a lender is whether you can pay the home insurance yourself instead of prepayment.

Title Fees

When purchasing a home, the lender needs to ensure there is a clear title to the property. Lenders do this by ordering a title search by a title company or real estate attorney.

The cost of title fees will range from area to area and company to company. Expect to pay in the neighborhood of around $1000.00.

Title Insurance Policy

You will be required to pay the lender’s title insurance, but you might also consider having the owner’s title insurance. The purpose of title insurance is to protect you against title defects.

Common title defects include incorrectly filed, forged, or lost deeds. They also offer protection against fraud, liens against the property, and any future encroachments that occur.

It can be especially beneficial when dealing with a bad neighbor who has disregarded property lines or didn’t know where they were when adding a structure.

Flood Insurance

If the property you are buying happens to be located in a flood plain, the lender will require flood insurance. Flood insurance is not cheap! This kind of insurance is a closing cost that many buyers will want to research in advance.

Real Estate Commissions

Most of the time, a real estate commission is paid for by the seller. However, it is possible that a buyer could pay a real estate commission.

For example, if you have hired a buyer’s agent and they find a for sale by owner property for you. In this circumstance, more than likely, their buyer’s agreement will say you owe a commission.

Commissions can vary tremendously, but you can expect to pay somewhere between 2-3% of the home price.

The Closing Costs Will Be Shown on The Loan Estimate and Closing Disclosure

Lenders are required by law to share with a borrower the closing costs involved with their home purchase. They do this at two separate times.

One is at the time of the mortgage application and then again with a closing disclosure.

The closing disclosure cannot be given any later than three business days before consummating the loan.

A loan officer should be going over all of the closing costs with a home buyer on both occasions.

Lender fees can vary, so it is vital consumers understand them. Average closing costs can jump when a lender charges higher than expected fees.

These two checkpoints prevent any unforeseen expenses for a buyer.

A Closing Cost Credit Benefits Buyers And Sellers

You should now have a much better understanding of what is a closing cost in a real estate transaction.

So how do closing cost credits benefit me, you might be asking yourself? Closing cost credits are designed to give buyers a bit of breathing room right after purchasing a house.

Closing on the house can be expensive and can leave buyers with nothing left over to take care of all the things that need care after becoming a homeowner. Additional home buying expenses after closing can include upgrades, repairs, purchasing furniture, and more.

Knowing these expenses are on the horizon can prevent potential buyers from entering the market and from buying your house.

Closing cost credits are also good for sellers. While at first, it may look like you are footing the bill for the buyer’s closing fees, what you are really doing is allowing the buyer to purchase your home in the first place.

This is especially true if you have a house that needs any repairs or upgrades to make it desirable. The buyer will need some way to bring the home up to standard, and the closing cost credit is one way to accomplish this.

Closing Cost Credits Can Pay For Home Improvements

Let’s say your home has old stained carpeting that needs replacement. You figure that it is probably around $5000 for replacement. Your potential buyer, when viewing the home immediately recognizes this is something they will need to do.

Unfortunately, the buyer does not have the funds to purchase your home, pay all of their closing costs, and then upon closing, dig into their pocket to come up with another $5000.

They structure the offer to have funds available to do that carpet replacement everyone agrees should be done.

Doing so is a win-win for everyone. You sell your home, the buyer gets the place they want and has the funds needed to spiffy up the property.

You Can’t Keep Closing Cost Credits As Cash In Your Pocket

Some buyers are under the impression that they can walk with the extra money in the closing cost credit, but this has not been true for several years. All mortgage companies will require that buyers use the money to pay towards closing costs like escrows, pre-paid interest, and taxes.

The benefit of the credit comes when the buyer needs to bring money to close on the house. If the credit covers the closing costs, the buyer only needs to get the down payment.

It’s a primary reason why buyers prefer a closing cost credit vs. a price reduction.

Of course, closing cost credits may not cover all closing costs, so buyers should get clarification from their Realtor before showing up to the closing with only the down payment.

When you consider all the myriad of costs when buying a home, it is understandable why buyers often ask for closing cost credits.

The Seller Is Not Really Paying For The Closing Costs

The best way for sellers to look at closing cost credits is as an additional incentive to buy the house. The actual money being paid to the seller is seen once the closing cost credit has been accounted for.

For example, if a home is offered for sale at $400,000 and a buyer offers $395,000 with a $5,000 closing cost credit, the seller will receive $390,000.

There is no difference to the seller of the home between the buyer requesting a closing cost credit like this and a buyer offering a straight $390,000.

Now, if you can get a buyer that will offer more money – when you look at the bottom line – then, by all means, you should consider the offer.

But if you want to sell the house and are happy to sell it for $390,000, there is no reason to get upset by the request for a closing cost credit. Today lots of buyers are asking for closing costs credits. This is very commonplace in real estate sales.

Closing Cost Credit Requests Are More Common With Some Mortgage Programs

If the buyer is using FHA financing or getting a VA Loan, an extremely popular mortgage product, the chances of a request for a closing cost credit go up exponentially.

These loans products are low to no down payment mortgage vehicles.

If you live in a rural area, the possibility exists a buyer may be using USDA mortgage financing as well. Borrowers getting this type of financing generally have significant incomes but don’t have large deposits or funds sitting in reserve.

Getting a closing cost credit or seller concession helps them immensely.

Frequently sellers ask me if they should consider this type of financing as if there is some additional risk. The short answer is that’s not the case.

Sellers should be more concerned about buyers who have marginal credit scores. A buyer’s credit history will play a significant role in getting a loan.

There are tons of buyers using these types of loans that are just as qualified, if not more than buyers using conventional financing. The key in all situations is to make sure you have a solid pre-approval letter from the potential buyer.

Closing Costs Credit Requests Should Be As Close To The Closing Costs As Possible

There is no real way to determine what the closing costs will be on a home until the day of the closing because the rates used to calculate closing costs vary day by day. Buyers should work with their Realtor to determine what they will request as a closing cost credit.

If the credit is more than the actual closing costs, the deal could get stalled while the paperwork is rewritten for the agreement, or the seller may wind up getting more money than was initially agreed upon.

When requesting a closing cost credit, the best strategy is to aim a little below what you expect the closing costs to be, just to stay on the safe side. All buyers should come close with enough money to cover the extra closing costs.

As long as you and your Realtor have done an excellent job estimating the closing costs when requesting the credit, the extra money you pay at closing should not be too much.

Benefits Of A Closing Cost Credit vs. A Price Reduction

Buyers should remember that a closing cost credit or seller concession may offer benefits over a price reduction on the home.

While a price reduction allows you to take out less money for your mortgage, it does not give you extra cash to fix the house or handle any additional costs that may come up after closing.

It is essential to think long-term about becoming a homeowner as a buyer. It will be especially true when purchasing a fixer-upper.

If you expect to need any money for things like repairs or improvements after you purchase the home, you may want to talk to your Realtor about a closing cost credit as an option for negotiations during the home buying process.

Closing cost credits are a great way to make real estate sales come together. They are a great tool in making more transactions happen.

They should be looked upon favorably by both buyers and sellers.

If you are selling a home, there is no reason in the world to be upset at a buyer for asking for this kind of concession. Always keep in mind it is your bottom line that matters!

A seller’s concession is a normal part of many real estate transactions!

Are There Any Drawbacks For Sellers?

From a seller’s perspective, one of the questions you may be thinking about is whether there are any drawbacks to having a closing cost credit or concession in a real estate transaction.

There is one potential downside, but it is minor!

One potential drawback for a seller doing a closing cost credit is appraisal problems. To make the math easy to understand, I will use a home selling for $100,000 as an example. Your home is on the market for $100,000, and you fully expect it will sell for full price or a net to you of $100,000.

A buyer comes along and offers you $106,000 but wants $6000 back as a closing cost credit. In real dollars, you are netting the same amount. No problem, right?

However, the issue that you need to make sure you won’t have is the home not appraising for $106,000. A low appraisal is not an issue most of the time, but you surely should discuss it with your Realtor.

Final Thoughts

By now, you should know precisely what a closing cost is and how closing cost credits work in a home sale. A closing cost credit should not be looked at unfavorably. Always look at what you’re netting from the sale.

Additional Helpful Articles on Closing Costs & Seller Concessions

• How do seller concessions work  – see a detailed explanation of closing costs and a seller’s concession via Mortgage Calculator.
• Home sellers will pay closing costs – learn why some sellers will have no problem paying buyers closing costs and why via Bankrate.

Use these additional helpful articles to understand why giving a monetary concession to a buyer when selling your home is not a bad thing. Keep in mind that the goal is to get the most money you can and get your home sold!

A closing cost credit can help many homeowners achieve these objectives.

About the author: The above Real Estate information on what is a closing cost and closing cost credits in a real estate offer was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for 35+ Years.

Are you thinking of selling your home? I have a passion for Real Estate and love to share my marketing expertise!

I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge MA.