There are closing costs traditionally paid by sellers, which are typically between 8-9% of the purchase price here in Florida. Among other fees, they include the Realtor® commissions.
Buyers using a mortgage to purchase a home pay roughly 3% of the purchase price in closing costs, depending largely on their lender’s fees. In addition, they pay prepaid costs into an escrow account. Those costs usually include 1 year and 3 months of home owner’s insurance and 3 months of property taxes. Those costs can vary greatly from home to home.
So each party in a real estate transaction has closing costs. When buyers ask for closing costs from the seller, also known as seller concessions, they are asking for the seller to pay a portion of the buyer’s closing costs and/or prepaids. They are reducing the seller's profit.
There is no Closing Costs Fairy
Ask your children to leave the room for a moment so that I can drop this bomb on you: There is no Closing Costs Fairy.
Your parents were responsible for your Christmas gifts, your Easter baskets and your tooth fairy money. When asking for a portion of closing costs and prepaids, understand that those funds are coming from the seller’s proceeds. It’s not uncommon and it’s totally okay, but it’s imperative that you understand the concept of a net offer. Also understand that if the market does not support the need for seller's to agree to seller concessions, it does not make sense for them to do so.
Your Net Offer
Many buyers are unclear about what closing costs are and where they come from. Closing costs do not go to the sellers. They are costs for things like title searches, title insurance and loan costs. When asking for closing costs, buyers must understand that the sellers are paying for them from their proceeds.
That means that your net offer is the purchase price minus the seller concessions. For example:
$350,000 purchase price with 3% ($10,500) to closing yields a net offer of $339,500.
That means that an offer of $340,500k is a higher offer by $1000. It’s also higher for other reasons that we’ll cover next.
Appraisal Value
When purchasing a home with a mortgage, there will be an appraisal to assess the value of the home. Home values are predominantly calculated using the sale prices of comparable homes and appraisers are especially strict since the recent market recovery. In order to move forward with a mortgage purchase, the appraised value must at least be as high as the purchase price. (There are technically other options, but they rarely ever come to fruition.)
That means that if you offer for the home in the example above at $350,000 with $10,500 to closing, the home must appraise at least at $350,000 (the purchase price), even though your net offer to the seller is only $339,500. For that reason, sellers and seller’s agents must be cautious about accepting offers that include seller concessions.
For that same reason, an offer of $350,000 with 3% ($10,500) toward closing costs is NOT as strong an offer as $339,500 without seller concessions, even though they equal the same net to the seller. That is because the offer without closing costs only has to appraise for $339,500. This is especially important to consider in a competitive market.
Should a Buyer Ask for Closing Costs?
That depends on the buyer’s needs. We’ve already established that a net offer is the purchase price minus the closing costs requested, so asking for closing costs means that the buyers will be taking out more money for their loan (the sellers will pay those costs at closing, but the buyers will have to offer more money in the purchase price, thus taking out more in the loan).
Buyers will essentially be paying for the closing costs either now or later, but they are still ultimately paying. If the buyer has enough cash to be able to cover all these costs, then it is best to submit an offer without requesting any seller concessions. It is a "clean offer" with fewer pitfalls and it empowers the buyers to take a lower mortgage, thus paying less in the long run.
However, if the buyer needs seller concessions in order to help cover some of the out-of-pocket costs (not uncommon), then seller concessions are needed. Keep in mind that the market and any competing offers will determine whether the seller agrees.
In some cases, buyers do have enough to cover all of their closing costs and prepaids in addition to their down payment, but they prefer to keep more cash for home improvements, moving, new furniture or maybe just to keep enough of a cushion in their savings account. This all makes sense as long as the market is one that supports this.
How Competitive is the Market?
It’s clear from the details above that, with all other things being equal, an offer without a request for closing costs is a stronger offer than one that requests closing costs. However, that is not to say that such an offer won’t be successful. There are many home purchases that include seller concessions.
In a less competitive market when the sellers are less likely to get more than one offer at a time, the buyers can be a little more aggressive with their offers (always keep in mind the concept of a net offer), because sellers will have the opportunity to counter if the offer is unacceptable.
In a competitive market when sellers are likely to get more than one offer at a time, buyers may have to submit their highest and best offer in order to compete. That means that the seller will not counter their offer; they will simply pick the best offer. Buyers must consider how much they want this home and what their other options will cost when submitting the offer. It is not uncommon in such a market and price range that buyers will submit an offer above asking price in order to make up for the requested seller concessions.
For example, if the buyer is searching in a competitive market for a home between $200k - $250k and they find a great home listed for $225k that is worth about $230k, then it may be worth their while to offer $235k with $5000 in seller concessions, that would be a net offer of $230,000.
If the overall costs are still within the buyers’ budget, the home is worth at least the purchase price offered, this is THE home they want and the alternatives will costs as much or more, then buyers still come out ahead in such a scenario.
Even if the buyer offers over asking price with an offer requesting closing costs, if there are other offers without requests for closing costs, the sellers will likely choose the offers without closing costs, because it is a less risky transaction.
Seek the Advice of a Good Realtor
There is no one size fits all in real estate and the basic precepts of seller concessions are no exception. The are several variables to consider in the offer process like location, price range, values, competition and more. For example, when buying new homes through builders, a common builder's incentive is to offer closing costs if buyers use one of their preferred lenders, so that is a different situation in which closing costs do not affect your offer in the same way. Those offers are simply part of the transaction.
Like many aspects of the real estate buying process, submitting offers works best when buyers are represented by a strong, well-versed and trustworthy Realtor®. There are many aspects that are important to each sale and strong representation is integral to a successful transaction. Your Realtor® should counsel you on market conditions, speak with the seller’s Realtor® in order to gain valuable insight and help you bring your home goals to fruition.
