Seller Paid Closing Costs – FHA Loans
FHA loans are a popular mortgage option among homebuyers, especially first-time purchasers and those with limited funds for a down payment.
One of the fantastic benefits of this program is that it allows the seller to contribute money toward the buyer’s closing costs. These are called “concessions” and they used to attract buyers and offers, making their property more attractive for purchases.
You might wonder why any buyer would ask a home seller to pay a closing cost credit for the buyer. The first thought that crosses a seller’s mind is “doesn’t the buyer have any money?” – and if the buyer doesn’t have any money, “why should the seller subsidize the buyer’s home purchase?”
However, it is common for sellers to pay a closing cost credit for some buyers in certain situations.
Here’s a brief look at the rules and requirements when a seller pays for some of or all of the buyer’s closing costs…
Seller Concessions and FHA Loans
Because this is a federal program, the US Department of Housing and Urban Development (HUD) sets the rules for seller contributions toward closing costs for FHA loans. It is their Single Family Housing Policy Handbook (HUD Handbook 4000.1) that outlines the regulations for the FHA loan program.
Their handbook further states that “interested parties” (seller, builders, etc.) can contribute money “toward the Borrower’s origination fees, other closing costs and discount points.” These contributions are generally limited to 6% of the sales price.
Believe it or not, seller contributions that exceed 6% do not happen very often. In most cases, these contributions fall at or below the 6% cap.
How Does It Work?
The number one way many buyers get the sellers to pay a closing cost credit is by increasing the sales price to cover the additional expense. For example, let’s say the sales price is $200,000, and the buyers need 3 percent of the purchase price. If you were to divide the sales price by .965 (a 3.5% down payment), that would equal $207,254. If you take $207,245 X 3.5% and deduct it from the sales price, the seller is still netting that same $200,000.
The drawback to this approach is what happens if the home does not appraise by the buyer’s lender at $207,245? If there is no provision for this in the purchase contract, the seller could be stuck paying a credit from a lower sales price and netting much less than the seller anticipated.
The Down Payment Portion
Homebuyers who use an FHA loan to buy a house must make a down payment of at least 3.5% of the purchase price or appraised value.
The FHA handbook states that “Interested Party Contributions may not be used for the Borrower’s [down payment].”
It’s the responsibility of the buyer to produce the entire down payment.
Offer a Trade Off for a Closing Cost Credit
Sellers will often agree to pay a closing cost credit if they get everything they want. Sellers want qualified buyers who will close escrow and not cause any problems during the escrow period.
In other words, offer to buy the home in its AS IS condition and assure the seller the buyer will take care of any home inspection issues after closing.
Too many sellers, it is worth it to give a little discount on the price upfront in return for assurance the escrow will close on time without hassles. Some sellers work a little flexibility into the sales price to begin with, so it’s not a hardship to offer a closing cost credit.
It’s important to distinguish that HUD allows home sellers to contribute toward the buyer’s FHA closing costs — but they do not require it. Seller concessions and contributions are typically agreed upon during the negotiation process, prior to closing.
Generally speaking, sellers tend to be more willing to pay buyer closing costs in a slower real estate market, and less inclined to do so in a hot market with competing offers.
In fact, in a sluggish market you’ll often see real estate yard signs that say things like “seller pays closing costs.” This is an enticement to attract more offers, which might be necessary in a buyer’s market.
In an active and highly competitive housing market, however, this kind of offer is less common. That doesn’t mean buyers can’t ask for the seller to pay some or all of their closing costs. It just means that the current state of the market will affect their willingness to do so. So when it doubt, rely on your real estate agent’s advice.