Seller and Buyer Costs at Closing

When negotiating a real estate transaction it is very common that the buyer will ask for the seller to pay the buyer’s closing costs. It’s become so common that when listing a house, many real estate agents, self included, prepare a seller’s estimated cost sheet with what their net will be with an offer that asks for closing costs, warranties and whatever else seems to be the current trend. Recently, I observed an online discussion on the matter that became rather heated when a seller asked if it was an ethical practice to increase the cost of the home to cover the seller’s concession for the buyer’s closing costs. While it is not unethical there is some worthwhile discussion needed on the topic. Which is what I would like to do in this hub.

In the case of the online forum, there was only one voice calling out for doing away with this practice and made suggestion that it was unethical. Other voices answered to transaction specific concerns and explained that it is perfectly fine, that such details are part of the negotiation and that it’s a matter of just working out details. So very quickly, here is a summary of the facts as I know them.

It is a common practice and does not violate the code of ethics. This practice is well known to occur and has not been addressed as any type of mortgage fraud. This is considered in the industry as a good way for buyers that otherwise couldn’t afford the entire out of pocket expense to get into a home. This is a good way in the industry for sellers to offer something that gives them an edge in selling their home- it opens up the pool of available buyers if the seller is willing to pay closing costs. From the bird’s eye view of any transaction, it helps things happen but, does that really mean it’s a good practice? What are the downsides and the risks?

The first and most obvious risk is that the home might not appraise at the new higher price. Not so many years ago you’d hear things from industry pros like “oh it will appraise, I’m not worried” which would make you worry that it was going to appraise because it was at that price, not because it was at that value. However, market conditions pretty much cut out lenders and appraisers that were in that school of thought so the risk now matches reality. It’s possible that the increase of $3000 to cover that buyer’s cost is just enough to price it above the loan value and then deal will fall through. The risk to the seller is that they took it off the market, waited 3 weeks only to find out that this buyer can’t get the loan at this price. So they can either renegotiate a new price but still keep paying buyer’s closing costs, or they can put it back on the market and start over and advertise things like- can close quickly! Title work done, appraisal complete!!! Bring a buyer!!! and so on. Often what will happen is that the seller is tired and wants it over with, drops the price in addition to paying those extra costs because it’s cheaper than a few more months of managing having it for sale. (It depends if the seller has moved out and is now managing two houses). This doesn’t always happen, sometimes it appraises just fine, everything goes without a hitch and the deal is done with no problems then recorded in the MLS as sold, seller gets their money and buyer moves in.

Even in the happy case of the above example where appraisal came in fine and closing happened on time, there is still a potential issue. So the home appraised at the new, higher price, when this home sale is entered into the local MLS, the tax records, online AVM sites and other places where it might be used for a comparable it might not show all the detail. The data is often incomplete and shows only that the house sold and the price for which it sold. So for example, if the house sold for $156,000 and the seller paid for $6000 of the buyer’s closing, title and prepaids this is not represented in the data or is rarely represented. When an appraiser comes along to use this home for a comparable, they see the amount of the sale, the sqft and other details about the home. It might be used as a comp and it may appear to others as if there were no concessions. To be fair to the topic of seller paying those costs, the problem being identified here is that the data is incomplete and the integrity of the data cannot be guaranteed. This fact alone doesn’t put the practice in question, only the reporting of the practice and a quick sample of sold listings will make it appear as if it rarely happens. However from personal experience and from the feedback in the online forum, it is a frequent occurrence, clearly there is a lack of continuity between what really happens and how well it is reported.

It’s not until you step back away from the transaction and instead of taking your look from the “bird’s eye view” you take a look from 10,000 ft that you start asking…is this practice really ethical? Is this practice good for the market? Who has the responsibility to look out for the market and why aren’t they getting involved? Once you start asking those questions it’s not so clearly “OK” to do these. It starts to look like more enabling, enabling of people to live beyond their means, enabling them to move into a home without having really qualified for the home. Buyer’s that otherwise would have had to buy a cheaper home or would have had to wait a bit longer were able to buy and move in. What happens for this buyer when there is a major issue with the home, perhaps the A/C unit needs repair- will they be able to afford this expense? What happens when the buyer changes jobs in 3 years and needs to move, therefore needs to sell this house only to find out that it appraises at the same price they bought it at 3 years ago so with the cost of their commissions and other selling expenses, they can only sell it as a short sale and since paying buyer’s closing costs are so common, they certainly can’t do that. So they can walk away, be stuck with the home, negotiate a short sale or become an “accidental landlord” renting their home since they have no real selling options.

Personally, I can’t say that the practice is unethical- it's legal and all parties agree to it freely and presumably are educated as to the risks for themselves. As a buyer, I tend to like the idea of having less money to let go of when I close- even if I have it available and can afford it, the idea of asking the seller to pay it is appealing. As a seller, I find it annoying but would be willing to work something out in order to get my house sold, after all, it’s only the bottom line of MY transaction that I really care about. As a Real Estate agent, I care about getting this transaction to closing, I’ve been either showing houses to that buyer or I have been marketing that home for the seller and it’s time to close it so my client(s) can move on with the rest of their lives and I can get paid for all this work. There isn’t anybody that is restraining me from helping with this transaction, from my narrow point of view on the ground or as I referred to it earlier, from the bird’s eye view, it’s a good thing that allows me to help Jane and Jim Doe get into this house. Unless I go looking for reasons to see it differently, this view is not going to change much, so I did. I started with a house I sold last year, representing the seller, it was one that we were nervous about the whole time because it seemed the buyer could barely qualify and the fear was the loan was going to fall through, but it didn’t. However, when I searched that address on county records, it shows to be in pre-foreclosure already. If I wanted a more “fair” sample I would check out every home I’ve ever sold, or check out all the homes that were sold last year in my market or some subset of it where the seller paid buyer’s costs and see what the foreclosure rate/short sale rate is. Problem is that you can’t trust the data to identify those homes and you don’t know what caused the financial troubles even if you had that data, it would just be wild speculation attached to a little correlation if there was one. What I can speak to is the feeling of knowing that it was a bad decision for the person buying, and the impact of foreclosures upon a neighborhood. We also know the impact of financial troubles on the market and upon marriages (and the impact of divorce upon the economy as well). All of those things are well researched and well documented now for years. I am not pro-regulation and tend to dislike the idea of the government trying to “fix” anything in the market, and would not dare argue that it become illegal for the seller to pay buyer’s closing costs. It’s not so much that a “fix” is needed to be put in place as much as an attempted “fix” is the cause and it needs to be removed or no longer promoted. There is a fine difference between the efforts to make mortgages not so hard to get and making them too easy. It might not be unethical to encourage and execute transactions where the seller pays closing costs, but neither is it unethical to encourage people to wait until they can really afford to make that move. I don’t disagree that it is ethical but also don’t mind saying it’s not good for the market long term and would appeal to others to encourage buyer’s wait until they don’t need these concessions before they move.