Seller concessions sound pretty good in theory. The seller will pay some of your closing costs? Yes, please!
Unfortunately, that's not really how it works -- and there are some serious disadvantages of a seller paying closing costs for a buyer.
Are you considering asking for seller concessions to lower your up-front costs? Here's what to take into account before you do.
It almost always means a higher sales price
Let's get this straight right off the bat: Sellers aren't paying your closing costs out of the goodness of their hearts. In the majority of cases, when a seller pays a buyer's closing costs, it actually results in a higher sales price.
Here's how it typically works:
- You, the buyer, ask the seller to cover some of your closing costs.
- The seller agrees, and their agent adjusts the purchase agreement by however much you want covered. If you ask for $5,000 in closing costs on a $200,000 purchase, for example, the sales contract would be upped to $205,000, allowing the sellers to still net the same profit.
- You apply for a home loan -- in that higher amount, essentially financing your closing costs and paying them out over time (plus interest, of course).
In very few cases will a seller actually outright cover closing costs out of their own pocket. In most scenarios, you'll see a higher sales prices as a result.
Your home might not appraise
In the event the concessions mean a higher sales price, you could find yourself up against appraisal issues -- not to mention potential financing problems.
If you're using a mortgage loan to pay for the home, your lender will likely order an appraisal, basically assessing the home's value. If the home appraises for the new sales price, you're in the clear, and your lender will give you the funds you need to buy the house.
If the home doesn't hit that new, higher sales price, though? Then, you'll have some trouble. Your mortgage lender will only give you the appraised amount, and you'll need to make up the difference (between the appraised value and the final sales price) out of pocket. If you can't cover the balance, it may mean losing out on the home altogether.
You'll pay more in interest over time
When a seller concession leads to a higher mortgage loan amount, it means more in interest costs, too. Here's a quick example: Let's say you're taking out a 30-year loan for $300,000, and you get a 3.5% interest rate. Without asking the seller to pay closing costs, you'll end up paying $184,968 in interest over the 30-year term.
If you ask the seller to pay $5,000 in closing costs, and it results in a $305,000 loan? You'll pay $188,051 in interest over time -- the difference of about $3,000. It would also mean a higher monthly mortgage payment (around $25 more per month).
You'll need a bigger down payment, too
Down payments are calculated as a percentage of your total loan balance. For example: On an FHA loan, you need to make at least a 3.5% down payment. On a $300,000 loan, that's $10,500. If you ask for closing costs and that balance goes up to $305,000, your down payment requirement jumps to $10,675.
While another $175 doesn't seem like much at first glance, when you couple it with the extra thousands you're spending in interest, it could mean a lot of wasted money in the long run.