Closing Cost Credits: Get Seller Credits or Lender Credits? What is a Lender Credit?

I sometimes have clients ask me how they can reduce the amount of cash they need to pay towards the purchase of a new home. Recently a client who was making an offer on a house that had an asking price of $650,000 wanted to make an offer of only $600,000 figuring that since they were putting 20% down, they’d save $10,000 by paying 20% down on $50,000 less in price. However, the house is worth what it is worth. And a buyer’s cash on hand has no bearing on where the house should be valued.

The better way to lower your cash out-of-pocket is to ask the seller to pay some or all of the closing costs. This is the case only if it can be negotiated in this current seller’s market. However, this usually requires a higher offer price. For example:

Assumptions

• Asking price of $650,000.
• 20% down payment.
• $630,000 is the almost agreed to price between buyer and seller.
• Closing costs for the title company, lender, escrows, and state/county costs are roughly estimated at 3% of the sales price, or approximately $19,000.

Outcomes

If this is how the offer ends up being accepted by the buyer, they’d owe:
• $126,000 for the 20% down payment.
• $19,000 for the closing costs.
• $145,000 total

However, let’s assume the buyer is tight on available cash for this transaction only wants to spend $130,000. And assume they’ll want to raise their offer price to entice the seller to pay all the closing costs. In this case, if the buyer can get the seller to pay all closing costs by offering to pay $649,000 for the house, then they’d owe:

• $129,800 for the 20% down payment on the slightly inflated purchase price.
• $0 for the closing costs since the seller would now pay them.
• $129,800 total

Conclusions

The buyer in this case does have to realize that by raising the sales price by $19,000 and using 80% financing, they have raised their loan amount by $15,200. And subsequently this will mean a slightly higher monthly payment. So there is a cost to this strategy of saving your cash. Assuming a 4.625% interest rate it would mean a higher payment by about $78/month.

Assume the borrower is qualified to handle the increased loan and assuming the property will appraise at the higher sales price. Some buyers do not have sufficient liquid cash and have no choice but to use this strategy.

Another way to reduce closing costs is to negotiate with your lender for a “lender credit”. Some people do this instead of negotiating with the seller for seller credits. A lender will credit you money towards your closing costs but charge a higher interest rate for it. However, a lender credit will not yield as many dollars and it would come at a higher cost.

For example, if you took a hypothetical 5% interest rate instead of a 4.625% interest rate you may get as much as a 1.50% lender credit. This is 1.50% of the loan amount. Assuming some of the same numbers above and using a $630,000 sales price and a $504,000 loan amount, this means you’d get a lender credit of $7,560. The 0.375% higher interest rate would cost about $114/month more. So in this case, it is clearly more beneficial to build closing costs into the sales price and get the seller to do a seller credit, rather than pay a higher interest rate to get a lender credit.