For many Massachusetts first-time home buyers – and for move-up buyers who might have lost equity in their homes during a real estate downturn – the biggest obstacle to purchasing a home often is saving enough money for the down payment and closing costs.
A home buyer purchasing a $300,000 home will need $15,000 for the down payment when using a conventional 5 percent down payment mortgage. A home buyer would need $60,000 for a 20 percent down payment that would avoid PMI. There are first-time and other home buyer loan programs that allow borrowers to put less than 5 percent down. Saving for a down payment is tough enough, but add several thousand dollars more for closing costs, and it's a real burden. One way to ease that burden is to negotiate a buyer credit at closing from the seller to cover some or all of the closing costs associated with a borrower's home loan.
Many first-time homebuyers refer to this buyer credit at closing as the seller paying for closing costs. The seller isn't actually paying for closing costs. The transaction is structured in such a way that a specific amount of the seller's proceeds, usually a few thousand dollars, is used to cover the buyer's authorized closing costs, settlement charges, and pre-paid items.
Many home buyers misunderstand the closing cost credit, and they think any amount of money can be agreed upon with the seller. In fact, lenders will not allow a buyer's credit to exceed the borrower's actual closing costs, so homebuyers need to have some idea of what the total estimated closings costs are before making an offer.
There are additional limitations as well. For a conventional mortgage (insured by Fannie Mae and Freddie Mac), the closing cost credit cannot exceed 3 percent of the purchase price, regardless of a borrower's actual closing costs. For an FHA-insured mortgage, the closing cost credit cannot exceed 6 percent of the purchase price.
What are Closing Costs When Buying a Home in Massachusetts?
In addition to the down payment, buyers need to pay closing costs. Closing costs are the collection of fees, expenses, and charges associated with purchasing a home with a mortgage loan.
How much you pay in closing costs will vary depending on the price of the property, the type of home loan, the lender, and whether the buyer is paying any "points" to lower the interest rate. One point equals 1 percent of the total loan amount, e.g., $3,000 on a $300,000 loan. First-time home buyers typically do not pay points when buying a home. FHA loans have additional fees not typical in other loan programs, including upfront mortgage insurance costs. Unless a borrower has a credit score too low for other loan programs, an FHA loan usually is not the best choice for most homebuyers.
In Massachusetts, New Hampshire, and Rhode Island, closing costs will amount to between $8,000 and $12,000. There are some loans without closing costs, sometimes referred to as lender-paid closing costs or no closing costs loans, but these loans are going to have a slightly higher interest rate, thus increasing the home buyer's monthly mortgage payment. The longer a buyer remains in a home the more likely choosing the lower interest will be the better financial decision. Your lender should be able to tell you how many years in the home it will take to be better off financially with the lower interest rate. Of course, if you don't have the cash for closing costs, you'll either need a no-closing-cost loan or will have to structure the offer so that the seller is providing the buyer with a closing cost credit (see below), sometimes referred to as a seller concession.
Types of Closing Costs in Massachusetts
Closing costs are often broken down into the following categories:
There are prorations/adjustments paid in advance of the closing by the seller, and the buyer will reimburse the seller for items that the seller paid in advance, such as pre-paid taxes, condo fees, and fuel costs (e.g., oil/propane already delivered to the house).
There are lender fees associated with obtaining a mortgage, such as origination fees, appraisal, credit report, tax service fees, flood certification fees, mortgage plot plan, and sometimes other fees.
There are several pre-paid items that borrowers will be responsible for at the time of closing. Lenders will typically require borrowers to pre-pay 12 months of homeowners insurance, the next tax bill, and the interest on the first month of the mortgage.
Borrowers likely will have to deposit reserves with their lender at closing. In most cases, home buyers will have to pay certain expenses of homeownership, particularly taxes and homeowners insurance, and the lender will hold that money in escrow. The lender wants to protect its investment, so collects these amounts from the homeowner and pays the taxes and homeowners insurance for the homeowner. After the closing, the money is collected every month from the borrower through the mortgage payment.
There are a number of title charges and fees related to the closing attorney's work payable at closing. There is the attorney's fee, lender’s title insurance (required), owner’s title insurance (optional, but recommended), title search fee, and several miscellaneous fees, such as final title run down (which is always last-minute), carrier fees (if applicable), wire fees (if applicable) and a mailing fee, because the lender will often require the closing package to be sent by overnight mail.
Homebuyers must pay state recording fees at closing for the deed, mortgage, municipal lien certificate (in Massachusetts), homestead deed (in Massachusetts), and real estate transfer tax (in New Hampshire). Only the seller in Massachusetts pays what is referred to as tax stamps, which is a transfer fee charged by the Commonwealth of Massachusetts equaling 0.456 percent (or $4.56 per $1,000) of the purchase price. In New Hampshire, the buyer and seller split the transfer tax; each party pays 0.75 percent (or $7.50 per $1,000) of the purchase price. In Rhode Island, the seller pays a transfer tax of $2.30 per $500, or $4.60 per $1,000.
Borrowers May Pay Points to Lower Interest Rate
As explained above, sometimes home buyers will pay a point (or a portion of a point or more than one point) at the closing. Each point is a charge equal to 1 percent of the loan amount. A point or points can be paid at the time of closing to lower a borrower's interest rate. It only makes sense to pay points to obtain a lower interest if you're certain you will not sell the home for many years; otherwise, the lower interest rate might not offset the added cost at closing. Your loan officer should be able to calculate for you how many years in the home it will take to justify the additional cost of points.
Seller Provided Credit for Closing Costs
There are federal laws that govern kickbacks and outside-or-transaction dealings between sellers and buyers and other professionals involved in a real estate transaction. Generally speaking, a seller is not allowed to offer anything of value to the home buyer other than what is being purchased as part of the property. For example, a buyer cannot pay $400,000 for a home and have the seller include his or her motor vehicle as part of the sale. On the other hand, items such as a washer and dryer frequently are included with a sale. Considering another example, a buyer cannot pay $400,000 for a home and receive a $10,000 concession for roof and HVAC work. If a property needs work, the seller would need to do the work prior to the closing, the home buyer would have to take the property as-is, or the buyer would have to get a renovation loan (sometimes referred to as a rehabilitation or "rehab" loan).
The one exception is that the Real Estate Settlement Procedures Act (RESPA) does allow a seller to contribute to the buyer’s closing costs. It is perfectly allowable – and quite common with first-time homebuyers – for the seller to pay a portion of the home buyer’s closing costs. It is also referred to as a buyer credit at closing.
How does a seller pay a homebuyer's closing cost? Typically, the way a seller pays for a homebuyer's closing costs is that the parties negotiate a net sale price (NSP). The buyer should know in advance what his or her estimated closing costs are expected to be at closing. The buyer submits an offer and the parties negotiate with the buyer credit built into the offer. For example, if a buyer wants to submit an offer for a property in the amount of $400,000 (NSP), and his or her estimated closing costs are $5,000, the offered price would be $405,000, and the offer would include an additional provision requiring the seller to provide a buyer credit at closing. For example, the provision may state, “Seller to pay Buyer a credit at closing in the amount of $5,000 for authorized closing costs, settlement charges, and pre-paid items.” The buyer credit is sometimes referred to as a seller concession.
Why Would a Buyer Want a Credit From the Seller for Closing Costs?
It's all about cash flow. A home buyer doesn't save any money by including a buyer credit at closing because the credit is simply added to the total price. A seller only cares about the net sale price. The benefit to the home buyer is not having to take that amount of money from his or her bank account (assuming the buyer has all the funds) to pay closing costs.
Structuring an offer with a buyer credit at closing is helpful in a number of situations, such as the following:
1. The home buyer is struggling a bit for the minimum down payment (discussed above), and it would be difficult to come up with the down payment and closing costs. In addition, lenders typically require that borrowers have a certain amount of money in reserve after the closing.
2. The home buyer has enough money for a 20 percent down payment, which will avoid mortgage insurance, sometimes referred to as private mortgage insurance (PMI), but does not have enough money for 20 percent down, plus the closing costs and required reserves.
3. In a situation where the home to be purchased needs improvements or repairs, a home buyer may simply rather have the funds in their bank account to make the improvements at the cost of a slightly higher monthly mortgage payment.
Are There Reasons a Seller May Not Want to Agree to a Buyer Credit at Closing?
Most Sellers will negotiate in terms of the net sale price, so there really is not much of a disincentive to consider an offer with a buyer credit for closing costs. Receiving an offer from a home buyer that has a buyer credit for closing costs does not mean that the buyer is not qualified or less qualified to receive a mortgage. It is strictly a cash flow decision on the home buyer's part, and it makes even more sense when interest rates are low. Sellers are receiving poor advice if they are discounting an otherwise strong offer that includes a buyer credit at closing. Sometimes, the listing agent simply isn't correctly explaining the closing cost credit to their seller.
The previous paragraph notwithstanding, there are three things a seller may consider before accepting an offer with a buyer credit for closing costs.
Commission. Real estate commissions are typically paid on the net sale price of a property, meaning the sale price, less any credits to the buyer; however, sellers would want to verify with their listing agent that the listing commission is based on the net sale price.
Transfer/Stamp taxes. Transfer/tax stamps are based on the gross sale price, not the net sale price, so a seller would pay an additional $22.80 in taxes for a $5,000 buyer credit (5 x $4.56 = $22.80).
Appraisal. In fairness to the Seller, increasing the purchase price to include a seller credit does cause a potential appraisal issue. Again, using the same example above, what if the appraisal comes in at $400,000 and not $405,000? Should the buyer really be able to cancel the agreement under those circumstances? If the Seller raises that issue in a negotiation, the home buyer might want to talk to his or her buyer agent and attorney about limiting the appraisal contingency to apply to the net sale price. If the appraised value is in between the gross purchase price and net purchase price, the buyer would have to make up the difference by adding more money to the down payment. Depending on the amount, the home buyer could be in about the same position as he or she would otherwise have been without the closing cost credit.
Determining whether to include a buyer credit at closing in an offer is just one of many important decisions a home buyer will have to make during the home-buying process. Working with a competent exclusive buyer agent and other experienced and trustworthy professionals is crucial to making wise decisions.