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When you buy a house, you’ll encounter a number of fees to finalize the transaction. These are called closing costs and tend to range between 2% and 5% of the home’s price. Think about that for a second. 5% of a $400,000 home is $2,000. That’s real money!
Sometimes, in order to make a sale go more smoothly, sellers may pay some of these closing costs or work with buyers to lower the overall home price. These are called seller concessions, and they’re a useful way for buyers and sellers to find common ground during a home buying negotiation.
Seller concessions, closing cost credits, and price reductions sometimes get thrown around almost interchangeably. They are different, however, and come with different benefits for both buyer and seller. In this piece, we’ll examine these terms and explore how they differ and how they can be beneficial to both buyer and seller.
What is a seller concession?
Seller concessions, sometimes called closing cost credits, are closing costs that the seller has agreed to pay. Sellers can cover part or all of a number of different closing costs, including:
- Property taxes through the end of the year.
- Title insurance, to protect the buyer and lender in case someone comes forth with a claim for the home’s title.
- Loan origination fees charged by the lender for processing the loan.
- Home inspection fees required by the lender for a sale.
- Recording fees required to document the home’s purchase with the local government.
- Appraisal fees in the event of a third-party appraisal.
- Attorney’s fees in states where you need an attorney to review closing documents.
- Mortgage points a buyer may have had to pay upfront to reduce their interest rate.
A buyer’s loan estimate shows all estimated closing costs. Depending on the situation, a buyer and seller can work together to identify possible concessions.
One example of a seller concession is when the seller actually increases the purchase price of the home. However, the home seller will use that additional profit to help cover the buyer’s closing costs. So what’s the point then? This adjustment helps the buyer lower their upfront closing costs by allowing them to roll that cost into their mortgage.
Let’s see this in practice: Say that a home’s list price is $100,000. The buyer needs 5% to help cover their closing costs, so they request a $5,000 seller concession. If the seller agrees, the final purchase price will be $105,000, but the seller will pay the buyer’s closing costs with the extra $5,000 they receive from the buyer’s mortgage lender.
Benefits of seller concessions
For buyers, seller concessions have the obvious benefit of lowering the amount they have to spend to buy the house. Since closing costs can often be a few thousand dollars, concessions could save the buyer a significant amount of money.
But concessions can also be beneficial for sellers in some situations. If you’re struggling to sell the house, offering concessions may get it off the market faster. A closing cost credit feels like an incentive or bonus to some buyers. With such a huge financial investment, buyers will be looking for ways to save some money upfront. They can instead put that money into furniture or home improvements.
Speaking of home improvements, if there are issues with the home that require maintenance, offering to pay closing costs for the buyer rather than make the fixes yourself can make the sale process go faster.
Drawbacks of seller concessions
As is usually the case in real estate, nothing is all pros and no cons. Asking for seller concessions may make you a less appealing buyer since most sellers prefer offers without strings attached. If a home has multiple bids, a seller will probably ignore offers with concession requests.
Additionally, sellers cannot cover all closing costs. How much a seller can offer in concessions depends on the type of loan a buyer uses.
Seller concession limits
Mortgage rule-makers like Fannie Mae and the United States Department of Housing and Urban Development (HUD) enforce concession limits to discourage housing market inflation. If sellers could offer any amount for closing costs, it may cause local housing prices to rise.
Sellers may want to offer to pay for closing costs to expedite the sale process or lower their tax burden. However, that may reflect a larger final price for the home, which can lead to inflation in the neighborhood.
As such, a seller can only contribute a small percentage to closing costs depending on the buyer’s loan. You calculate the amount a seller can pay in concessions based on the lower number between an offered sale price and the property appraisal value. These are the concession limits for common loans:
- Conventional loans: Sellers can contribute up to 3% if a buyer’s down payment is less than 10%, up to 6% if a buyer’s down payment is 10%-25%, or up to 9% if the buyer’s down payment is more than 25%. If the property is an investment and not a primary residence for the buyer, however, the seller’s contribution is maxed out at 2%.
- FHA loans: Sellers can contribute up to 6% of the home price for all FHA loans. Again, “home price” in this instance means the lower number between the appraised value and the actual sale price.
- USDA loans: Sellers can contribute up to 6% of the buyer’s loan amount.
- VA loans: Sellers can contribute up to 4% of the home price. Seller concessions may include payments toward a buyer’s judgements and debts or VA funding fees in addition to closing costs.
What is a price reduction?
A price reduction, as the name suggests, is pretty straightforward. A seller simply accepts a lower offer than the original listed price of the home.
The benefits of price reductions
What buyer doesn’t want to pay less than the list price for anything? Price reductions are great for buyers for the obvious reason of paying less, but they can also be good for sellers in a few ways as well.
1. Lower sales price reduces your selling fees
When you sell your home, you generally have to pay a number of fees. For instance, the standard commission for using a real estate agent is about 6%. Other fees, like escrow fees, title fees, and transfer taxes increase with the value of the sale. Some states also trigger extra costs when the sale price exceeds a certain number. For example, Connecticut charges 1.25% in taxes on any amount over $800,000.
When you sell for a slightly lower price, all of these fees are lower. In most cases, the higher sale value will make up for the increase in fees but a small price reduction may end up saving you money.
2. Reduce the capital gains tax
Thanks to the Home Sale Tax Exclusion, people who sell their homes can write off up to $250,000 of profit ($500,000 for married couples) on their taxes. But if you exceed the exemption, you’ll owe either short-term capital gains, taxed as ordinary income, or long-term capital gains, taxed at thresholds of 0%, 15%, or 20%. If you’ve owned the home for a year or less, you’ll owe short-term. Any longer, you’ll qualify for a long-term capital gains rate.
To calculate your capital gains, you take the sale price of the home minus selling fees and subtract your adjusted cost basis (e.g. the original price of the home plus capital improvements.)
If you exceed a $250,000 profit, you may owe a significant amount in taxes. A CPA can help you figure out the exact tax ramifications of your home sale but in many cases, a price reduction makes sense to ensure you can write off the entire profit from your sale.
3. It can help a buyer out
The housing market was hot in 2021, but it won’t always be that hot. You can’t expect to have multiple offers lining up so when you get a serious offer, you should treat it seriously. Still, even serious buyers may be on somewhat shaky financial ground.
If a buyer asks for a closing cost credit, they may be tough negotiators, or they may have to stretch to reach your price.
Rather than cover some of the buyer’s closing costs, sellers can make the process easier and faster by bringing down the price. That will help reassure the buyer’s lender that they can afford the house and mitigate the risk of a buyer walking away. If you just want to sell and be done with the process, taking a little less is a generous and practical thing to do.
4. Risk of a low appraisal
In a hot market, you want to list your home at the high end of what your agent thinks it’s worth. A buyer comes in and bids even higher than you asked. Great, right?
Not so fast. The buyer’s lender will undoubtedly set up an appraisal. Although home values have appreciated at rapid rates all over the country, appraisals haven’t necessarily kept up. Low appraisals can be a real problem for sellers. A lender will not approve a loan for a house that’s priced too high.
Unless you’re in a very hot market where competitive buyers keep driving up the price, you should at least consider a price reduction to meet the expectations of lenders. Otherwise, you might be holding onto the house for a while.
There’s power in compromise. That’s the key when it comes to seller concessions. Yes, concessions may require sellers to pay a little money out of pocket or give up some negotiating power, but they’re a good tool to make real estate transactions go smoothly. And they could even save you money on taxes or closing fees. Before you take a hard line, at least consider what concessions might be able to do for you.