Did you know that there is more to negotiate than the price of a home when you buy a home? You can also negotiate other things, such as closing costs with a seller. If you don’t have the cash lying around to cover up to 5% of the loan amount, you may need this help if you want to close the loan. Luckily, the FHA loan program does allow sellers to help with closing costs.
Keep reading to find out what closing costs a seller can pay.
The Fees Sellers can Pay
Sellers can help you with a large number of the closing costs charged by your lender. For example, if your lender charges you origination points to do the loan, your seller can cover those for you. Origination points are usually 1% or 2% of your loan amount. On a $200,000 loan, that can be as much as a $4,000 fee that the seller can cover.
If you want to lower your interest rate and the lender requires you to pay discount points to do so, the seller can pay those as well. Like the origination points, discount points are a percentage of your loan amount. It’s common to pay 0.5% or 1% of the loan amount to lower your interest rate a little.
The FHA also allows sellers to cover any type of lender or 3rd party charged closing costs. The most common charges include:
- Processing fee
- Underwriting fee
- Credit report fee
- Appraisal fee
- Title Fees
- Lawyer fees
- Document preparation fees
- Closing Fees
The seller can also cover any prepaid interest that you owe at the closing. Prepaid interest, as the name suggests, is the interest that you pay upfront. This is because you pay interest in arrears on your mortgage. When you set up a new mortgage, you typically don’t make a payment until 45 days later. For example, if you closed on May 15th, you wouldn’t make a mortgage payment until July 1st. That July 1st payment would cover the interest for June, but you still have to cover the interest from May 15th to May 31st. This is the interest that the seller can cover for you at the closing.
What to Watch For
Your lender will carefully look for any excessive payments that the seller makes on your behalf, as this could be considered an inducement to purchase. When a seller covers your costs, it should be out of good faith and not in an effort to convince you to buy the home.
The lender and/or FHA wants to know that this is an arm’s length transaction. In other words, there isn’t a relationship between anyone involved in the transaction. They also want to know that there isn’t any sort of ‘bribing’ going on that would make you feel as if you have to buy the home because of what the seller is doing for you.
The Limit of What the Seller can Pay
While the FHA is liberal in what they allow the seller to cover, there is a limit. The seller cannot pay more than 6% of the purchase price of the home in selling costs for the buyer. If your purchase price is $200,000, the seller may contribute up to $12,000 in closing costs. If the seller contributes any more than this amount, it’s considered an inducement to purchase (like we discussed above).
If your seller does contribute more than the 6% limit, the mortgage lender will do one of two things:
- Deny the loan
- Reduce the loan amount dollar for dollar based on the excessive help from the seller
For example, if a seller contributes $2,000 more than the 6% limit, the lender would decrease your loan amount by $2,000. This means that you would have to come up with another $2,000 for the down payment. As you can see, it’s not worth it to have the seller cover anything beyond the 6% limit.
Other Ways to Get Closing Cost Help
If your seller isn’t willing to help you or they can only provide a little help, there are a few other ways that you can get closing cost assistance on an FHA loan.
First, if you are eligible to receive any gift money from relatives or your employer, you may use the funds for your closing costs. You must let the lender know that you are using gift funds, though, as they need to document the funds and their origination. In other words, the lender needs to make sure that the funds are actually a gift and that you aren’t required to pay them back as a part of a loan either from a bank or a person.
If you don’t have access to gift funds, you may also get help from the lender. Some lenders offer what they call a ‘no closing cost loan.’ This is just a fancy name for taking a higher interest rate in exchange for the lender covering your closing costs. If you have good credit and pose a low risk of default, your lender may be willing to offer this option. While you’ll take a 0.5% higher interest rate (an estimation) on your loan, you won’t have to cough up the thousands of dollars that are necessary to close the loan.
One way or another you can get help with your closing costs, but you have to abide by the FHA and lender rules. Talk with your lender about your ability to get some closing cost assistance and weigh the pros and cons of each option available to you. This way you can choose the option that will cost you the least amount of money over the life of the loan.