Both buyer and seller have closing costs and prepaids related to their sale or purchase… referring to expenses you must pay at the closing table beyond the seller paying off any mortgage(s) or the buyer's down payment.
Some examples of these closing costs/prepaids are…
- Fee for closer's services
- Pro-ration of taxes between buyer and seller
- Buyer financing expenses
- Buyer homeowner's hazard insurance
- Setting up buyer escrow account for taxes and insurance for mortgage company to make future payments on your behalf
- Title examination/insurance
- Recording fees to tranfser title
- Broker fees
- Seller commission
Typically most of the seller's cost is commission and most of the buyer's cost is related to financing.
So if both buyer and seller have closing costs, what are "seller paid closing costs"?
"Seller paid closing costs" usually refers to a credit from the seller to the buyer at closing to reduce the amount of cash the buyer needs to close. It is most commonly used by buyers short on cash as a way to finance some of their expenses.
So… why would a seller do this? The seller has closing costs of their own! Think of it as another way to negotiate price. For example, an offer of $200,000 with $5,000 contribution to buyer's closing costs is a net offer of $195,000. The purchase price can also be increased to cover the closing cost contribution, but keep in mind that the property must appraise for the increased amount. For example… you agree to a purchase price of $200,000 but the buyer needs the seller to contribute $5,000 to their closing costs so the purchase price becomes $205,000.
For many buyers it is essential to finance some of their closing costs through "seller paid closing costs" to have the funds to close… they qualify for a higher mortgage but don't have any more cash. While it used to be this applied primarily to cash poor first time homebuyers, many move-up buyers are now affected as well. They may have lost equity in their homes and not net enough from the sale of their current home to pay all the closing costs on the purchase of their next home.
So does this mean the seller simply pays all the buyer's closing costs?
No, you negotiate how much the seller will contribute as part of the purchase agreement, provided the buyer's financing will allow it. Most mortgage companies have guidelines of a maximum seller contribution of 3% of the purchase price for conventional mortgages and maximum 6% for FHA and DVA loans. If you ask for a bigger contribution than you can use for your closing costs, it usually means the seller keeps it… you don't get a refund and it cannot apply to your down payment. That's why it is important to talk to your lender to get an accurate estimate if you want to ask for the maximum allowed to reduce your out-of-pocket closing costs to a minimum.