This post is long overdue. It's probably one of the top questions I get from both buyers and sellers, both of whom think some sort of enormous advantage (or disadvantage) is to be had with this little trickery. If you are unsure how closing costs really work, this article is for you!
What Are Closing Costs When a Home Sells?
Lets start with some basic information. What, exactly, are closing costs? Closing costs come in two types. There are the costs for closing your loan, which are typically things that don't change. They include processing fees, lender fees, points: all that stuff. They also include things that can change a lot depending on WHEN you close: pre-paid taxes, pre-paid mortgage, pre-paid insurance, and things of that nature. For the purposes of this discussion, all those items are closing costs. (To learn more about typical closing costs, check here).
How do Closing Costs Work?
Now that we know what they are, let's talk about when they happen. Closing costs happen when the home is exchanged and title is handed over. In real-estate parlance, It's done at the close. Closing costs are added to what the buyer is paying for the house, and it's all laid out on the HUD, which is the official counting of the transaction.
Who Pays Closing Costs When a Home Sells?
Sellers Can Pay Closing Costs,
The buyer always pays closing costs. I'll say again: the buyer ALWAYS pays closing costs. So what do they REALLY mean when the SELLER agrees to pay closing costs? We shall see below, afterall, closings costs are often thousands of dollars. Wouldn't all buyers want the seller to pay them?
When the Seller Pays Closing Costs in a Home Sale Purchase, what Really Happens?
When the seller pays closing costs, the money to pay those costs comes from the "Sale" of the home. So when you look at a HUD (a settlement statement for a housing transaction), the HUD shows money from the "seller's side" going over to the "buyer's side". See, that was easy, the seller just paid for your closing costs! Or did they? Let's take a look at an actual transaction to see what happened.
Typical Transaction when the Seller Pays for Closing Costs
We're going to keep this simple for this transaction. Our seller has a mortgage of $200,000, which he owes the bank, and he wants to sell his home for $300,000. He markets the home at $310,000, and he gets an offer right away (because he listed with me...) at $300,000. Good. All set. The seller will be taking a check home from the closing for $100,000, which is what he wanted.
The Buyer calls at P & S (Purchase and Sale) and decides that he would like the seller to pay for $5000 of closing costs. No problem, we re-work the paperwork so that the buyer will pay the seller $305,000 and the seller will pay the $5000 back to the buyer for the closing costs.
"Hey, wait a minute," you say. "The seller is getting the same net! They didn't pay for anything!"
That's right. Seller's aren't dumb. They can do basic math. They are happy to pay for closing costs as long as the net they expected is the same. So there's no "free money" here. So if the seller isn't out any dough, who paid for the closing costs? Answer: The buyer. Put another way, let's say the seller has two offers: One is at 300K, but he doesn't have to pay closing costs, the other is at 303K, but he has to pay 5K in closing costs, and other than that the deals are equal. Which do you think he takes? Which would you take? Well, since the second only NETs you 298K, I'm betting you'll take the extra 2K. So don't be fooled: You can't sneak closing costs past a seller, any more than someone could sneak them by you.
The Reason Why Sellers Pay Closing Costs
Now the whole reason this happens is so that the buyer can FINANCE the closing costs. The seller pays them, but really, the bank is letting you borrow "extra" to pay the bank's own closing costs. So instead of having to take $5000 out of your checking account to pay those closing costs, you can roll it into the mortgage, for about $25/month for the next 30 years. Due to the various lending laws and guidelines, there are precious few things that you can "roll" into the mortgage. But you can, generally, roll closing costs in, so most buyers would be wise to take advantage of this financial tactic. You can always pay it down later, but when cash is tight, this is usually the way to go. This is a good option as long as you need the cash more than you need to avoid the extra debt. Although it can be hard to remember, for the most part, when housing is going up in value, it's a leveraged investment, and the more it's leveraged in an up market, the better your return on invested capital is going to be.
Hope that clears things up! If your're looking for more on closing costs, check here
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