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Seller Paid Closing Costs
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If you are thinking of buying OR selling a home, seller-paid closing costs (“SPCC”) -- costs that the seller pays on behalf of the buyer -- may be a vehicle that should be considered.
What are seller-paid closing costs (“SPCC”)? What are the ramifications to the buyer or seller? How are typical seller costs, as described in the purchase agreement, different from SPCC? What do lenders allow?
Seller-paid closing costs are classified as “Interested Party Contributions". Most lenders allow at least 3% in "Interested Party Contributions" and in some instances more, for the purchase of a primary home or secondary residence. This 3% can include normal closing costs, such as origination or discount points, a rate buydown, title fees, and even escrow set-ups and prepaid insurance and interest costs. An interesting thought might also include a buy-out of the buyer’s lease for their current property (in order for the buyer to close on the new property more quickly).
A buyer is able to purchase a home with just a minimal 5% down payment investment. The transaction needs to be structured carefully, though, because the buyer MAY NOT take cash out of any excess funds that the Seller contributes as SPCC.
So, let's assume for the moment, that according to the purchase/sales agreement, the seller has agreed to pay the real estate commission, seller’s title fees, and any other charges traditionally considered to be paid for by the seller in the specific market area. Why would the seller want to pay for any of the buyer’s costs? The answer is: To be more flexible to meet the buyer’s needs and/or desires. But the rest of that answer is because it “shouldn’t cost the seller any more money to be flexible”, and with a little more effort, helps “seal the deal”.
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| There are at least two ways to incorporate SPCC into the purchase agreement: At the beginning of negotiation, SPCC could be included in the purchase agreement; During negotiation, SPCC can be added via addendum by either the Buyer or Seller. Please note that in order for SPCC to be acceptable to the lender, the appraisal value will have to meet or exceed the sales price after SPCC have been added.
A question may arise about potential tax consequences that the seller will incur as a result of the higher sales price. I am not a tax accountant and am not qualified to give tax advice. It is my understanding, however, that according to personal tax advice given to me, the tax basis of the property being sold is increased by the amount of the seller contribution made in order to sell the property. My final advice on this subject, though, is to ALWAYS make a call to your tax adviser to see what tax impact the sales transaction will have upon you, as the seller.
The other issue that might arise will be “What should the actual sales commission be predicated upon?” General practice is that the Seller ask their listing agent to create an addendum to the listing agreement that states that the Realtor’s commission will be paid on the agreed-to sales price, less any SPCC concessions -- since the whole purpose of the SPCC concession is to allow a Buyer who might otherwise be unable or unwilling to purchase the property to do so.
ADVANTAGE TO THE BUYER
The buyer is able to purchase the home with a minimal investment of 5%, and not have to worry about having to invest another 1.5% - 2% for closing costs. Or, with a little stretching of the Buyer's resources, SPCC may allow the Buyer to maximize their investment into the property. Using SPCC, the Buyer may be able to put 10% down instead of 5% down (or 20% down instead of 15% down). A higher down payment may impact the Buyer's rate of interest by 1/8%.
DISADVANTGAGES TO BUYER
Although the Buyer using SPCC may have less cash demands upon them at closing, the Buyer needs to remember that in New Mexico the sales price is reported to the county in which the home purchase is made. The county assessor will assess taxes eventually on the acquisition cost (final sales price), and that tax basis will follow the Buyer throughout the lifetime of ownership of the property.
Because the SPCC contribution is added to the sale price of the home, the loan amount generally increases, as well, since the loan amount is usually calculated as a percentage of the sales price. Consequently, for every $1000 of SPCC added to the loan amount, the Buyer should plan on about a $6.00 - $6.50 increase in the monthly mortgage payment.
ADVANTAGE TO SELLER
Because the cash requirements from the Buyer will be less, the Seller has a potentially larger buyer market exposure.
DISADVANTAGE TO SELLER
None.
LAST COMMENTS:
I want to point out again that the appraisal value must come in at or in excess of the sales price, which includes the SPCC. If the appraisal comes in for a lesser value, the Buyer will need to be prepared to come in with some or all of the closing costs.
SPCC is only one of a group of tools that can be used to market or sell a home. Be sure you are working with a professional Realtor and lender who will thoroughly discuss the impact of SPCC on your side of the transaction.
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