Real Estate Closing Costs Paid By Seller a Catch-22

Real estate closing costs can with certain limits be paid by the seller without detriment to the buyer if you know the rules. Ignorance of the rules can turn real estate closing costs into a Catch-22.

Why is this important?

It can be the difference between a loan approval and a loan denial.

Seller contribution is a fancy way of saying the seller can pay for certain buyer real estate closing costs. For example, a seller could “contribute” or pay up to 3% of the real estate closing costs on behalf of the buyer. If the buyer’s loan program caps for allowable seller contributions is exceeded, the overage is called a seller concession. Seller concessions as defined here serve to reduce the buyer’s loan amount dollar for dollar potentially causing the buyer problems when it comes to cash needed to close

For example, say you want to buy a $100,000 home and you have 5% down payment and not a penny more. The standard FNMA guideline at 95% only allows for a 3% seller contribution toward costs. Let’s also assume you qualify for a $95,000 loan and not a penny more. The loan is structured as a $95,000 conventional loan that allows for 3% in seller contributions which the seller agrees to pay. The 3% equals $3,000 but you discover the total real estate closing costs are $3,500!

Where is the extra $500 going to come from? You don’t have it. You can’t raise the loan amount based on our assumptions. It’s got to come from the seller, right?

Wrong.

According to program guidelines, 3% is the max contribution and any extra would be classified as a concession reducing the loan amount and still requiring you come in with $500.

There’s the Catch-22…sellers cover costs to close the deal with cash-strapped buyers…but give too much, and the sellers self-serving generosity actually kills the deal.

In the real world, there are solutions about 99% of the time. But I added this scenario just to illustrate how not knowing the Catch-22 in the underwriting guidelines can cause real problems.

The same holds true for the FNMA Flex 100 loan program..only 3% allowable seller contribution with a borrower required $500 minimum cash investment. Run the numbers to see if your loan amount/sales price will provide enough cash to close with the limited seller contribution and buyer required $500.

Then, always make sure the contract provides for the seller to “pay buyer’s closing costs, prepaids, escrows, etc. up to but not exceeding 3% of the loan amount” rather than the typical clause, “seller agrees to pay $xx.xx toward buyers closing costs” so you’ll be in compliance with underwriting requirements and don’t have to get contract amendments every time the sales price is renegotiated up or down.

For example, if the sales price is say, $150,000 on a FNMA Flex 100 then the loan amount is $150,000 too. Let’s say, the real estate closing costs, prepaids, escrows, etc. will total $4500. We’ve got a buyer who literally has only $500..no more. Subtract his $500 from the $4500 needed to close. That leaves the seller picking up $4000 remaining cash needed to close. Since 3% of $150,000 is $4500, the clause above and the underwriting rule will limit the seller to the remaining $4,000 and all is well in Poohville.

Hold on though…

What if the sales price of this Poohville ranch house was only $100,000 with $4,000 in total costs?

Seller’s max contribution is only $3,000 plus buyer’s required $500…we only have $3500 when we need $4,000!

Oops…all is NOT well in Poohville anymore.

In states where real estate closing costs are high even on cheap properties…like New York and Florida…this could really be a problem.

One solution when the deficit is only $500: Someone just waives part of their fee to solve the problem…that means the mortgage broker or the agents usually. Or if the buyers qualify and desire a slightly more expensive home, that can solve the problem many times as well, especially when the spread starts to climb past $1,000 and no one wants to take that big a hit to their commission.

Either way knowing just how to avoid these real estate closing costs Catch-22’s is second nature to an experienced, ethical mortgage broker and they can help you and your agent structure the deal and get the necessary clauses in the contract correctly from the beginning.

If you want to learn just how to locate a local ethical mortgage provider who will always get you the best rate and closing costs, check out our mortgage shopping system.

Good Luck!

Author: Rob K. Blake
Published December 5, 2007

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