What is a Seller Credit at Closing?
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Apart from the down payment for a mortgage, purchasing a house involves a lot more other costs and fees you have to pay at closing, as well as repairs that may need to be done around the house. That being said, when all of these costs add up, the buyer may not be able to afford to pay for everything at closing. This is where seller credit comes in. Seller credit is an amount of money that the seller contributes to the buyer’s costs at closing. Apart from helping the buyer pay the closing costs, seller credit also serves as an incentive to buy.
What You Should Know
- A seller credit is an amount of money that the seller gives to the buyer to cover some of the costs at closing
- Seller credit can be used to pay for some of the buyer’s closing costs, needed repairs, to have a faster sale or attract more prospective buyers
- Lenders put limits to the amount sellers can contribute to the buyer’s closing costs
- Seller credit cannot be used towards the buyer’s down payment
What is a Seller Credit?
When the seller of the house gives the buyer seller credit, it means that they offer to pay for some of their closing costs or other costs involved in purchasing the house. Seller credit is a common tactic that helps sellers sell the home faster. For example, if someone is on the verge of buying your house but they cannot afford to pay some of the closing costs, instead of losing this potential buyer, you can offer them seller credit. Moreover, if you offer seller credit from the start, you may be able to attract more buyers.
The number of sellers who offer seller credit will depend on the conditions of the housing market. If it is a buyers’ market, that means that buyers have the upper hand, therefore sellers should try using seller credit to make their offers more attractive. On the other hand, if it is a sellers’ market, then as a buyer, you won’t be able to find many sellers who are offering seller credit.
When can a Seller Credit be used?
There are different reasons why a buyer may ask for a seller credit or why a seller might offer one. Among others, the most common uses for seller credit include:
Repairs Needed - If the home inspection reveals major repairs need to be made to the house, the seller can offer a seller credit to the buyer so that they don’t back off the deal. This way the buyer does not need to spend more of their own money in repairing the house and the seller does not have to start the process of looking for a buyer once again. The seller does not give the money to the buyer directly, but he pays for some of the closing costs so that the buyer has more funds to cover the repairs.
On-the-fence buyers - If you are a seller who is looking to sell the house as soon as possible and move into your new place and the buyer you have been in negotiations with hasn’t made a decision yet, you can offer a seller credit to make the offer more attractive. By doing this, the buyer may be more inclined to accept the offer and purchase the house.
Attract more prospective buyers - If it is a buyers’ market, it means that there are more people who are looking to sell a house than people looking to purchase one. This can make it especially difficult for sellers to find a buyer, which is why seller credit can get the house noticed among other alternatives available to buyers.
Closing Costs - The down payment of a mortgage and its closing costs require a big amount of funds from the buyer, which they may not afford to pay upfront. The buyer can ask the seller to include some of the closing costs into the purchase price and then have the seller pay for the closing costs.
Example - Closing Costs
Imagine that the current purchase price of the house is $250,000 and the closing costs are $8,000. The buyer intends to make a 20% down payment. What is the amount required at closing?
The buyer cannot afford to pay $58,000 at closing. Instead, the seller decides to increase the sale price by the closing costs and provide the buyer with a seller credit amount equal to the closing costs. What is the amount the buyer has to pay now?
Since the closing costs will now be covered by the seller credit, the buyer would need to pay for the down payment of $51,600.
| Without Seller Credit | With Seller Credit | |
|---|---|---|
| Purchase Price | $250,000 | $258,000 |
| Down Payment | $50,000 | $51,600 |
| Closing Costs | $8,000 | $8,000 |
| Seller Credit | $0 | $8,000 |
| Amount owed at closing by Buyer | $58,000 | $51,600 |
| Savings | $6,400 | |
There are, however, some complications to this process. First, the home needs to be appraised to the new purchase price. If it doesn’t, the lender may not agree to lend the total amount to the borrower and instead may require them to put down the difference between the new sale price and the appraised value of the house. Secondly, the borrower needs to qualify for a larger mortgage. Lastly, increasing the home purchase price and getting a larger mortgage means that the borrower’s mortgage payments will be higher throughout the life of the loan.
What costs can a seller credit cover?
Seller credit can cover most of the general closing costs in taking out a mortgage and purchasing a home. These include:
- Loan origination fee - This is the fee a lender charges for the whole process of evaluating your mortgage application, gathering documentation, verifying financial records and information. This fee for the processing of your loan is typically 0.5% - 1% of the loan amount.
- Discount points - A borrower can purchase discount points to lower the interest rate on their mortgage. One discount point typically costs 1% of the mortgage amount and reduces your mortgage rate by 0.25%.
- Appraisal Fee - The lender needs to appraise the property in order to verify that the home sale price matches the home’s appraised value. This is usually a fixed fee of $350.
- Inspection Fee - The seller credit can be used to pay for the cost of getting a home inspection. This fee can vary based on what the specific inspector is charging and the size of the house. It usually ranges from $300 - $500.
- Title Insurance Fee - Title insurance is used to protect the borrower and their lender against losses and defects to a home’s title and ownership. This type of insurance is required by lenders and it typically costs from 0.5% to 1% of the home price.
- Attorney fees - You may be required to get an attorney, who will help you review and verify your closing documents.
- Recording fees - Government agencies require the recording of every purchase or sale of real estate. Recording fees are required for the service of maintaining the official documents.
- Property taxes - The borrower is required to pay two months of property taxes.
- Repairs - The home inspection may reveal that there are repairs that need to be made around the house. The seller does not pay the buyer directly for the costs of repairs that they negotiate on. Instead, the seller can give seller credit which is applied at closing, which then gives the borrower more money to spend on doing the repairs.
Seller Contribution Limits
Lenders set limits to the maximum amount the seller can contribute to the borrower’s closing costs. The table below summarizes the contribution limits set by conventional and non-conventional lenders for residential and investment properties.
| Lender | With Seller Credit |
|---|---|
| Conventional < 10% Down Payment | 3% |
| Conventional 10% - 25% Down Payment | 6% |
| Conventional >= 25% Down Payment | 9% |
| FHA | 6% |
| VA | 4% |
| USDA | 6% |
| Investment Properties | 2% |
- 1. Conventional lenders such as Fannie Mae set different contribution limits depending on the down payment made by the borrower. For example, for borrowers who put down less than 10%, their sellers are not allowed to contribute more than 3% to their closing costs. Meanwhile, the borrower is permitted to get a seller credit of 6% if they make a down payment of 10% - 25%, and 9% if the down payment is at least 25%.
- 2. FHA Loans restrict the amount a seller can contribute to 6% of the home price. This amount cannot be used to pay for the down payment, just the closing costs. If the seller will pay for the upfront MIP of an FHA loan, then they must pay in full, as FHA does not allow partial payments for its upfront MIP.
- 3. VA Loans have an even lower contribution limit of 4%. You can use this amount towards the VA funding fee or closing costs such as prepayment of property taxes, insurance, discount points, etc.
- 4. USDA loans allow a seller contribution of 6% of the sale price.
The rules above apply only to residential properties. Investment properties, on the other hand, have a seller contribution limit of only 2%.
Why are there limits to seller contributions?
Contribution limits were put in place for two main reasons. First, contribution limits serve as a measure for borrowers not to purchase a home that they can not afford in the long run simply because the seller is offering to pay a substantial amount of the closing costs. While the borrower may afford to pay the upfront costs with a generous seller contribution, this does not mean that they will afford to make the mortgage payments down the road.
Secondly, seller contribution limits ensure that house prices are not inflated artificially. For example, when the house price is higher than normal but the seller has agreed to pay a high seller credit. This would have consequences on the housing market.
Benefits and Drawbacks of seller credits
Buyers
Pros: Seller credits make buying a home more affordable for buyers. The large amount required at closing or the cost of needed repairs can be a deciding factor in a buyer’s ability to purchase a house. Seller credits leave buyers more room to breathe, so they don’t have to spend all of their lives’ savings on purchasing a home.
Cons: Your offer may seem less attractive if you are a buyer asking for seller credit, especially, in a sellers’ market. Here sellers receive multiple offers on their house, so asking for a seller credit may undermine your chances from the start.
Sellers
Pros: Seller credit can help sellers sell their homes faster. Not only can it be an incentive to an on-the-fence buyer to make the ultimate decision and purchase the home, but it can also attract more interested buyers, leaving you to choose from a bigger pool of candidates.
Cons: Agreeing to or offering a seller credit means that you will make a smaller profit on the house than you would have otherwise. If you are in a hurry to sell the house, make sure you have explored all other alternatives before offering a seller credit.
FAQ - Seller Credit
Can seller credit be used to pay for the down payment?
No. Seller credit cannot be used to pay for the down payment on a house. It can only be used to cover closing costs and needed repairs. This is because the lender uses your ability to make a down payment to evaluate if you will be able to afford a mortgage in the long run.
What happens if the seller credit exceeds the closing costs?
If the seller credit exceeds the closing costs then the lender credit must be reduced to reflect the borrower’s closing costs. Another option is to apply the portion of the seller credit that exceeds the closing cost as a principal curtailment to the mortgage. A principal curtailment is when the borrower makes extra payments towards the principal of the mortgage.
Is a seller credit tax-deductible?
No, sellers can not deduct seller credit when filing their taxes. However, seller credit can be added to the cost basis of the house to reduce the profit or the net capital gain realized on the home’s sale. By doing this, the seller would pay less in capital gain taxes.