There are a lot of different costs and fees associated with the buying a new home. Your loan estimate will break down the different parts of your mortgage loan, like the estimated interest rate and monthly payment. It will also include the estimated settlement costs, more commonly referred to as closing costs.
Depending on the type of loan you get, you may be able to get the seller of the property to cover some or all of your closing costs. This can be decided during your sales contract negotiation.
What are closing costs?
Before we get into the specifics, let’s take a look at what closing costs are, and what fees and services are included.
Closing costs are things that have to be paid in order to close on your home, like property taxes, homeowners insurance, title search fees, appraisal fees, etc. People involved in your loan need to get paid and services performed throughout the process are due at closing. All of these costs are lumped together under the umbrella of closing costs.
Even though they’re called closing costs, you may be asked to pay for some of them as the actions happen, like home inspections and appraisals. While your estimated closing costs will be included in the loan estimate, many of the fees listed can and will change along the way.
Below is a list of common items included in closing costs. Each state has different requirements, so some items mentioned below may not apply to your individual situation. There may also be some miscellaneous costs that don’t fit into these categories, including things like home warranty fees, courier fees, and wire fees.
Additionally, items like transfer taxes, mortgage insurance, and title insurance are not flat-rate costs. Even though everything will be itemized and broken down for you at closing, you shouldn’t hesitate to ask your mortgage banker to explain any part of your loan costs if you don’t understand them.
Who pays for what?
Homebuyers can negotiate and even ask the seller to cover all closing costs, although every transaction between buyer and seller are different and guidelines vary by loan type.
Closing costs are generally 2% to 6% of your purchase price. For example, if a home costs $200,000, closing costs might be between $4,000 and $12,000. Conventional loans, FHA loans, USDA loans, and VA loans allow the seller to contribute to closing costs, but each loan type has different rules and guidelines as to how much a seller can contribute to closing costs.
Conventional loan guidelines are a little more restrictive than other types of loans. Depending on the buyer’s loan-to-value (LTV) ratio and downpayment, a seller can contribute anywhere from 3% to 9% of the sales price in closing costs.
FHA and USDA Loans
FHA and USDA loans allow the seller to contribute up to 6% of the sales price toward closing costs, prepaid expenses, discount points, etc. The funds from the seller can also be put toward the down payment, although a down payment is not required for USDA loans.
For a VA loan, the seller can pay all of the buyer’s closing costs and prepaids related to the mortgage, including up to two discount points to buy down your interest rate. Additionally, they can pay up to 4% of the sales price toward discretionary costs, which can help cover things like appliances, paying off debts (such as car loan/credit card), etc. No other program will allow the seller to pay discretionary costs, making VA loans very unique.
Why would the seller be willing to cover my costs?
It may seem odd that a seller would be willing to pay your closing costs, but there are advantages for both parties.
For the buyer, the clear advantage is that seller concessions are a way to lessen the financial burden that comes with getting a mortgage loan.
There are also tax advantages for the buyer when discount points are involved. Discount points are tax deductible for the buyer during the year after they buy a new home. Discount points are prepaid interest on your mortgage loan. Typically, one point is 1% of the loan amount and borrowers can have up to 4 discount points on their loan.The more you pay in discount points, the lower your interest rate will be. So, for a $200,000 home, 4 bonus points would be $8,000 of prepaid interest
For the seller, covering some or all of the closing costs is a way to sell their home faster. Sellers are often trying to buy a home, so a smooth, quick sale benefits them as well.
Buying a home is a big decision and investment. If you’re buying a new home, make sure you understand your closing costs and talk to your mortgage banker to figure out what kinds of seller contributions to closing costs are possible for your transaction.
For more information on closing costs and the mortgage process in general, read more on Atlantic Bay’s blog.