"In an effort to sell my house I agreed to pay up to $8,000 of the
buyer's closing costs. Is there anything I can do to keep the amount as
far below $8,000 as possible?"
At this point, no. If you agreed to pay "up to" $8,000 of the buyer’s
costs, you will almost surely end up paying $8,000, or very close to it.
Why a
Seller’s Commitment Is Almost Bound to Be Fully Used
If the buyer is astute, any part of the $8,000 that is not needed to pay
the lender’s fixed-dollar fees or third party fees will be used to pay
points that reduce the borrower’s interest rate. This is called “buying
down the rate.”
Points are lender fees expressed as a percent of the loan balance, and
lenders trade off points against the interest rate. Low rates require
high points, high rates command negative points called “rebates.” Points
are settlement costs and are therefore covered by the seller’s
commitment. The astute borrower will use any part of your $8,000
that is left over as points that reduce his rate.
If the borrower is not aware of his option to
buy down the rate, the excess very likely will end up in the pocket of
the loan officer or mortgage broker. Where it will
not end up
is back with you, the seller.
Rationale For the Practice of Home Sellers
Paying Settlement Costs
The practice of home sellers paying all or part of a buyer’s mortgage
settlement costs arises from the effort to qualify potential home buyers
who don’t have quite enough cash. A potential home seller looking to net
$300,000 for her house may broaden the market by pricing the home at
$308,000 combined with an offer to pay up to $8,000 in settlement costs.
Paying $308,000 for a house with the seller committed to paying $8,000
in settlement costs permits a larger loan and therefore requires less
cash from the cash-short buyer than paying $300,000 without the
commitment.
For example, assume the borrower is putting 10% down and settlement
costs are $8,000. If the price is $300,000, the buyer needs cash equal
to 10% of $300,000, which is $30,000, plus $8,000 in costs, which add to
$38,000. When the price is $308,000 with no costs, the buyer needs only
10% of $308,000, or $30,800. Hence, if the buyer can come up with
$30,800 but not $38,000, the higher price with a settlement cost
commitment has succeeded in expanding the market.
Provisos
The major proviso is that the appraised value must match the price
inclusive of the settlement costs. In the example, the appraiser must
report that the house is worth at least $308,000. If the house is
appraised at $300,000, the buyer’s cash requirement won’t be reduced. In
the years prior to the financial crisis, appraisals were largely
accommodative, today less so.
A second proviso is that the seller’s contribution must fall within the
lender’s guidelines. Lenders restrict contributions, based on how much
the buyer is putting down. Fannie Mae and Freddie Mac set a limit of 3%
of the price when the down payment is 10%, so the contribution in my
example would be an acceptable 2.6%. Note that FHA allows contributions
up to 6% regardless of the down payment.
I sometimes run into larger contributions where the payment by the
seller is made outside of closing so it can be concealed from the
lender. That is a fraud.
Will the Buyer Receive the Full Benefit of the
Seller's Contribution?
The cash constrained buyer who agrees to pay $308,000 to receive an
$8,000 contribution should aim to use the $8,000 to pay fixed-dollar
lender fees (those not related to loan size) plus third party charges
such as title insurance, and use whatever is left to buy down the
interest rate by paying points. For example, if fixed-dollar lender fees
are $800 and third party charges $2200, the $5,000 remaining should buy
down the rate on a 30-year fixed-rate mortgage of $277,200 (90% of
$308,000) by about .75%.
But an avaricious loan provider can easily thwart this strategy unless
the buyer knows how to protect himself. If the buyer is dealing with a
mortgage broker, the $5,000 may end in the broker’s pocket as extra
compensation. The buyer can protect himself against this by negotiating
the broker’s fee from all sources in advance, and putting it in writing.
If the buyer is dealing with an avaricious loan officer (LO) employed by
the lender, the $5,000 likely will be used to pay points, but the
interest rate may not be any lower than it would have been without the
payment. To protect herself, the buyer needs to know the competitive
rate on her transaction inclusive of the $5,000 in points. She also
needs to be able to monitor the price until it is locked. The only
effective way to do this is to access an on-line site such as mine that
provides transaction-specific prices.
Buyers should be particularly wary of offers by builders that they will pay all settlement costs if the buyer uses the builder’s preferred lender. The interest rate paid by buyers accepting this attractive-sounding offer is bound to be higher than the rate available from a competitive lender providing a rebate large enough to cover the same settlement costs.
