The Beginner’s Guide to Closing Costs, Credits and Price Reductions

The Beginner’s Guide to Closing Costs, Credits and Price Reductions
February 23. 2021

Are you in the process of buying a property? Closing cost credit is a system in which you can reduce your final fees when buying a property. If the property search has left you tight on funds, you need to know how it works to reduce those extra expenses. 

Many people go for closing cost credits instead of a reduction in price. Which of these is actually best as a buyer? Below, we discuss the value of closing cost credit vs price reduction.

What Is a Closing Cost?

Once you have lined up your mortgage and made an offer on a property, you need to go to an office to do the closing. This is where you will sign all the legal paperwork so that ownership of the house can transfer to you. 

During the whole process of finding a property and arranging the finances, a number of people will have performed services for you. These could be the mortgage lender or real estate agent. Paying the fees they are owed is known as the closing cost.

What Is a Closing Cost Credit?

To incentivize people to buy a property, a seller may offer closing cost credit. This is a way to offset a buyer’s final closing fees, allowing them to retain more money after the sale. This credit can be negotiated and must be decided upon before the transferral of property deeds. 

You may also find that a real estate agent offers you closing credits. They may only offer credits coming from their commission, and this can not exceed the total amount of closing costs. 

Closing costs credit from the seller will not be found in hot markets, where the advantage is on their side. However, they may be used instead of necessary repairs. This is because lenders will be unlikely to sign a loan on a property that needs open repairs, killing off a transaction or sale. 

General Closing Cost Credit Rules

Firstly, closing cost credit can never exceed the amount of the total closing costs. This may happen when more than one person you are dealing with offers closing credit. If this happens, the credit is simply wasted. 

Generally, lending programs will allow closing costs credits to run up to 3% of the purchase price. In rare cases, it may be as high as 6% or 9%. In investment property purchases, it is often limited to 2%. 

Closing cost credits can be used to pay both recurring and non-recurring fees. Non-recurring fees include one-time payments like underwriting, appraisals, and such forth. Recurring fees include interest, property tax, and insurance.

Before discussing credits, check with your lender that it is allowed. They will tell you the maximum allowable credits, check the total closing costs so that they do not exceed that amount, and discuss any closing cost credits they may offer or have in place. 

Negotiating a Selling Price Reduction

An alternative to closing credit is a reduction in the sale price. Everyone wants to get their property cheaper, and a seller will even expect some negotiations to occur.

When negotiating, start by getting your finances in order. A seller is more likely to offer you a better deal if they know the transaction can go through smoothly. If the question of you getting a mortgage is in doubt, then this may not be the case.

Secondly, know the market you are buying in. If there are many properties available and few buyers, you can afford to go in a little heavier. If it is a seller’s market with few properties and many people buying, then your negotiation efforts will be limited. 

Making sure you get an inspection is also a great way of negotiating. This lets you know everything that may be wrong with the property, which you can use when discussing the price. You also do not want to find out about these surprises after the sale, when the property is in your hands. 

Closing Cost Credit vs Price Reduction

There are a number of opinions on which is better. Both of them have advantages and disadvantages, that finally comes down to your situation and preferences. 

Firstly, many people argue that it makes no difference to the buyer or seller. A seller providing $7000 in closing fees is the same amount out of pocket as $7000 reduced from their asking price. 

However, there are some trains of thought that say a price reduction is better for the seller. For one, it reduces their overall fees, including potentially reducing the taxable capital gain. For this reason, you may find a seller pushing for a price reduction over the provision of closing credits. 

Which Is Best for the Buyer?

As a buyer, closing costs can run particularly high. Even the smallest of homes can expect costs around the $10,000 mark. This can add an awful lot to the overall cost of buying a property.

Closing cost credits significantly reduce the amount you need to close the deal. That $10,000 may be significantly reduced, leaving you with money to spend on home improvements or furniture. 

When you compare this to the value of a reduction in the sale price over the tenure of an average mortgage, the closing cost credit becomes much more appealing. Yes, the mortgage will end up marginally higher, but it is not likely to be a noticeable increase. Weighed up against the value of the immediate cash reduction, anyone who may be tight on funds should definitely opt for the credit. 

Discuss With Professionals

When weighing up the closing cost credit vs price reduction debate, it helps to speak to professionals. Your agent and mortgage lender will know the best strategy and have experience in the field. Discuss your options with them before making any offers. 

If you are looking to get a loan for a property, the Market Place Mortgage Corporation can assist. We offer purchase and refinance loans and can even provide closing cost credit. Click here to use our mortgage calculator, and take the steps towards getting your dream home today!