Have you ever had a question about seller credits and ended up scribbling notes like Russell Crowe’s portrayal of John Nash in A Beautiful Mind? We understand.
We often are asked this question by interested buyers. When looking in a price range for a property, the amount of money necessary “to bring to the table” at closing remains important. Outside of the financed amount for a property, a buyer needs to have the amount of the down payment and enough for the other closing costs to close the transaction. These closing costs can differ, and a good lender should be able to provide an estimate detailing the costs. We typically estimate these costs to be 3 to 4% of the purchase price.
To help offset these closing costs, a buyer can request a seller credit. This credit reduces the amount due to the seller and credits that same amount to the buyer’s side of the closing statement (effectively offsetting a portion of the aforementioned closing costs). But how?
Let’s take an example. A home is listed for $200,000. A prospective buyer makes an offer at full price and requests 3% of the purchase price ($6,000) as a seller credit. If agreed to, the seller’s proceeds will be reduced by $6,000 and the buyer will have $6,000 contributed to their closing costs. In game and economic theory, this is termed a “zero-sum game”, whereby the loss of one party is offset by the profit of the other party.
Another way to lessen the burden of closing costs is to “finance” the closing costs by way of “grossing up the purchase price” and requesting a seller credit. Using the previous example, a counter offer from the seller could be as follows (the bracketed information denotes the source of the numbers).
$200,000 [List Price] / 0.97 [100% - 3%] = $206,185.57 [New “Grossed Up” Sales Price]
$206,185.57 [Grossed Up Price] - $200,000 [Original Price] = $6,185.57 [Seller “Credit”]
In this scenario the seller credit is essentially covered by the lender (not the seller) and will be paid back over the term of the loan. As such, most lenders have a limit of 3% of purchase price in using this method. It does allow the buyer some relief in covering closing costs but does not save money in the long term.
Remember, when grossing up the contract price, it also increases the hurdle that the appraisal must reach. In this scenario, the appraisal must now meet or exceed $206,186 (rather than $200,000).
Hopefully this helps to explain both the buyer’s and seller’s positions in the question of seller credits. Some math is involved and it is quite important to understand the effects from each side. Just one more reason to work with an agent and real estate company that can help to explain and work though your scenario.
Written by: J. Turner Swann