Closing Cost or Down Payment?

Can money from a seller be used for a down payment??
The easy answer here is no.
But……
It really can’t just be divided between closing costs vs down payments like most people think though.

It is sort of hard to grasp but it is really more complicated and simple than that.

Lets start off with removing “down payment” and “closing costs” from our vocabulary.
I would rather use words that are actually more descriptive and avoid the negative over simplifications.
I prefer to think in terms of overall “initial investment” and “credits, discounts, and service charges”
Some of the service charges after all, like appraisals or inspections have to be paid no matter if there is a closing or not so it is inaccurate to call that a “closing cost”. You also get the equity in the house for your required down payment so that is your investment and it helps reduce your monthly payments.
Some lender fees also help reduce monthly payments, so I like to just say that is your investment.How much should you invest? The less you put in to it the higher your payments are later. Then we have taxes and insurance which are just a facts of life but they are what secure and protect your investment and the community.

I usually recommend to my clients to try to ask for the seller to pay for at least some if not all of their service charges, pre paid items and other fees because it reduces the buyers funds required to close. And in some case borrowing more or paying more for a house to pay discount points or prepaid interest can save more monthly than taking a higher rate at a lower purchase price.
There are times when money is better applied to a discount point than to a down payment. Other times, particularly if the lower payment does not pay for it self in a reasonable time frame or if the buyer knows they have a very short term in a home, I recommend to pay as little as can be.

In all reality though the buyer actually is still paying for their own expenses because it is rolled in to their loan via the purchase price which might be lower if the seller did not agree to pay this expense. Or rolled in to the interest rate if there are lender credits or reductions in charges.
The Truth in Lending disclosure accounts for this “rolled in” finance charge but non lender related service charges are only initially itemized on the GFE and later accounted for on the settlement statement through invoice and receipt accounting.
We do our best to know what will be required to close but often our clients can not understand why we do not have exact numbers when we do our disclosures. They assume the process to be an exact science which it is and is not. The GFE, more than anything, try’s to explain the complexity and worst case of itemized costs involved in the loan process. The #s on it mean less than the narrative. It is after all, a good faith “ESTIMATE” so really there is no reason anyone should begin to expect that it contain actual exact numbers but it can help to explain where all of your money is going to. I have seen this disclosure change over the years from a relatively simple list of the range of charges that could be seen to a three page detailed itemization that attempts to address every possible cost and totals everything from government funding fees to specific looking assumptions about third party charges like home owners insurance, taxes, and detailed title company service breakdowns based on one service provider who may or may not be the actual company used in the transaction. Our disclosures on GFEs are usually higher than what is eventually realized in actual charges because we like to show the worst case and to error on the side of caution and consumer protection. Most of the charges on the GFE are actually assumptions about third party charges required to facilitate the transaction. In almost all cases the total of government loan funding fees, appraisal, title costs and insurance charges will exceed our origination service charges. We often can even deliver services with out charges and with lender credits from interest rate premiums we can sometimes eliminate our fees and other company’s charges. if the borrower elects that option when available.

In Indiana a lender can charge up to 5% in APR effecting fees. That is still lower than most realtors charge to list a property but our compensation is limited to compliance with federal regulations and can not change from deal to deal. Our branch office averages about 1 to 2 percent in total fees and often we credit more back than what we actually charge or can do closings with no lender fees.
The TIL on the other hand or Truth In Lending disclosure uses a complicated formula to to conceptually simplify things and accounts for the long and short of things. This document that shows the APR helps a buyer see the overall big picture.
Q:
Can the seller help with the initial investment?
Well……
There are cases where programs allow for a combined loan to value and the practice of seller held 2nd mortgages was popular before the mortgage crash. For the most part though, money for down payments has to be sourced or seasoned and funds from a seller is a big no no.
But……
The moneys in mortgage loans are somewhat fungible. Conceptually in the end it’s really just about funds to close not really what is what.
The main thing I like my clients to understand is that….
Often exact funds (to the penny) to close are unknown until a day or so from closing.
The allocation of funds will occur as needed for compliance and ultimately will be lower than anything I have shown them prior to close.

Lets take an FHA transaction with 3.5% down and a 3% seller concession on a $100,000 purchase price.
3.5% of the borrowers money or documented gift for that amount is required to be shown and must be put in to the deal as the initial investment. So $3500. A buyer might give $500 in earnest money which would reduce this after the evidence of the check clearing the bank is submitted. But the full $3500 and any other funds needed and not covered by a seller concession has to be shown in the buyers account as available.
Now from the seller….
$3000 plus the property tax credit will be applied to the total deal as a deduction from the buyers side after all service charges and loan funds are accounted for. The tax credit money is actually viewed by us as the buyers money at closing along with moneys already paid for appraisals, inspections, earnest money or lender credits.
Here the 3% paid by the seller and credits may reduce funds to close and be applied toward the initial investment of the required 3.5% the borrower has to have in the deal because the buyer will be reimbursed for money already spent which was theirs to begin with.
The loan is figured at 96.5% of the purchase price of available money for the transaction. Any government funding fees are stacked on top of the loan. In this case FHA requires 1.75% so the loan amount increases to 98.25% with 1.75% set aside to cover the fee.
I have had clients bring no money to close on FHA loans because they had large deposits in earnest and upfront and pre-paid items paid by the seller or huge tax credits that exceeded escrow set up requirements. That did not mean it was a no down payment transaction like you might really have in USDA or VA lending but it was a no cash to close situation. However the funds used still had to be sourced as money available and already invested in the deal.

I always try to get a preliminary settlement statement from the title company in advance of closing that includes our fees to get the buyer somewhat closer numbers for closing but still exact figures will be determined by other factors such as the exact closing date to calculate odd days interest and prorated taxes and there may be additional charges or changes associated with third parties beyond the lenders control.
Depending on how things shake out the $3000 could be used to refund money paid for the appraisal or homeowners insurance annual premium which in the end results less cash to close. It may not seem to the buyer that they paid this money as a “down payment” but it is included in the required investment and it may reduce what is actually needed to close so I guess that’s what it is. It is not correct to say that the seller concession was used to pay for any part of the down payment money but that is sort of what it seems like because it is money thought to be already spent.
In Indiana right now assuming normal circumstance I recommend my clients ask for about $3000 that usually covers the cost of their title work, any non government base fees we might have (excluding discount points or added origination) and provides a little help in setting up escrow accounts or for recouping money from prepaid items.
Most government loan programs allow for up to 6% to be paid by a seller for the buyers cost of doing business so you see that $3000 on a $50,000 deal might be pushing that limit and would leave no room for additional points after covering the service charges that are mostly fixed expenses. However on larger purchases there is plenty of money available to pay discount points to buy down the rate or even pre-pay interest to reduce future payments which is the basis of Platinum’s exclusive Dream Loan product where seller concessions can actually be used to provide interest free payments for up to 6 months!

James C. Werner
Branch Manager
529 Main Street Lafayette Indiana 47901
765-532-1604 Cell / Text
NMLS ID#137331