When I talk with prospective home buyers, one of the biggest surprises is how much it cost to buy a home. Most buyers expect that they will need to come up with a down payment, and with FHA requiring a minimum of 3.5% down (and that can come from a gift), but it is often a shock that there are additional charges they will need to come up with at closing, and in order to even qualify for the mortgage we will need to see that they have the ability to come up with the cash needed to close. Besides the down payment, some of the items you will need to pay for include:

• Bank fees, including the appraisal and credit report, underwriting and processing charges.
• Title charges.
• Transfer taxes. In Chicago the transfer tax is .75% for buyers, or $2,250 on a $300,000 home, so this can be a big item.
• Attorneys fees.
• Home inspection costs.
• The first year’s insurance payment.
• Pre-paid interest and the money to set up your escrow accounts (you will get a tax credit from the seller, which will reduce your costs).

Add these together and you are looking at thousands of extra dollars you will need at closing. Coming up with the down payment and cash needed to close is usually the biggest obstacle to buying a home, especially for first time home buyers. But the good news is that you don’t have to save all this money before you can buy. You can ask the seller to help you buy their home by contributing to your closing costs. We are in a buyer’s market, and with the leverage on the side of the home buyer, this has become a normal and accepted part of many transactions. If you want to make use of a seller credit, you have to ask up front when you are negotiating for the home. From the seller’s perspective this is the same as offering a lower price for the home. Any money that the seller pays out is deducted from the sale price. If the contract for the home is $200,000 and they are paying $3,000 for closing costs and pre-paids, the true sale price is $197,000. So the seller is more interested in how much they are netting, not how the transaction is structured. This applies to short sales and foreclosures, too. I have heard many people say that you can’t ask for seller closing cost credits when buying a distressed property, but that is simply not true. If a closing cost credit will help, ask for it.

FHA allows up to a 6% seller concession (though they have talked of reducing this to 3%) and you can get up to 3% credit on conventional loans. Work out the numbers with your lender beforehand, and have him put together an estimate of closing costs so you know everything you will need to cover at the closing. You can ask for these closing costs either as a dollar amount, or as a percentage of the purchase price. Because there are so many fixed items, the percentage needed will be much higher for lower priced items (bank fees and title charges) then for higher priced homes, so there is no rule of thumb as to what percentage of the sales price you will need. The closing cost credits have to be used at the closing and you can’t get any cash in your pocket from the credit, but you want to make sure that you use it all.

The most common way to use a seller credit is to use it to pay off your closing costs so you don’t need as much cash at the closing. But there are other, more creative ways to use the seller credit, which can work great for specific situations. Sometimes the seller credit can make the difference between buying, and waiting another year. Here are a few ways you can use a seller closing cost credit:

Pay off Up-front MIP  – One of the major costs of an FHA loan is the up-front mortgage insurance premium. This is now 2.25% charge, but it is usually added into the mortgage so you don’t pay it in cash. For most borrowers this is just a cost of doing business and worth the price to take advantage of all the benefits of FHA financing. But if you are only planning on being in the home for a relatively short period of time, it may be an issue. One solution is to use a seller credit to pay off the up-front MIP. By doing this you have in a sense, increased your equity by 2.25%. You will also lower your monthly payment by a bit. One thing to keep in mind is that the premium has to be paid in full or not it all. It can’t be split or reduced.

Buy down the interest rate – You can also use the credit to permanently lower your interest rate. The seller credit will pay for points, or up-front interest charges. Usually 1 point (one percent of the loan amount) will lower your rate by about 1/4 of a point in interest. If you are planning on being in the home long term, this could be a great way to lower your payment and save a lot of money over the course of the loan. This can also be used to help you qualify for a higher amount.

Temporary interest rate buy down – Another option is instead of lowering your payment for the life of the loan, to lower the payment much more in the first few years of the loan. An example of a temporary buy down would be a 2-1 buy down. If current rates are at 5.0%, this buy down would mean that you pay 3.0% for the first year, 4.0 for the 2nd year and then the market rate of 5.0% for the next 28 years. The cost of the buy down is the difference in payments for lower rates you are paying for the first 2 years, paid at closing (this will usually be around 2.5% of the loan amount). There are 2 main advantages of going this route. First, with FHA, you can qualify for the mortgage with the first year’s payment. This is a big advantage if you know that your income will be going up. The other big advantage is flexibility. I am working with a client now who can afford the home priced as it is, but is nervous about the jump in payments compared to their rent. At the same time, they have some expenses that will be dropping off soon, and the spouse is finishing up school so more income will be coming in over the next few years. A temporary buy down is the perfect solution.

Seller tax credits can be a great way to extend your buying power, save money and structure your loan in a way that works best for your needs. If this will help, be sure to work the numbers out ahead of time and negotiate it into the contract.

Peter Thompson 630-479-6424

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