After an accepted offer, my sellers received the inspection report back from the buyers of their house. The inspection report stated that the property needed a new roof. They asked my sellers to pay for the entire roof but we negotiated down to about half the quoted amount.
How do those funds get transferred? Do they get credited to the buyer at closing? Does the seller hand over the cash at closing? How do sellers give buyers money for repairs or replacements found in the inspection? How exactly do seller credits to buyer work?
The cost of buying a home or condo can add up quickly for buyers. For financing deals, buyers can usually round in any additional costs into the full loan amount such as closing costs and appraisal fees. Typically buyers pay loan acquisition costs such as escrow processes and title insurance. However, the buyers can ask the seller to credit them a specified amount at closing to help with any of these expenses, including items found on the inspection report. The seller concession must be included in the sales contract and the amount and terms of the credit can be negotiable, just like anything else in the sales contract.
Both the seller and the buyer pay their share of closing costs to settle the transaction. These fees include escrow fees, title insurance, property taxes, courier fees, earnest money deposit’s, down payments, homeowner association fees, and any other minor fees that get rolled into the lump sum of closing costs. Lenders typically require buyers to pay the fees which are considered customary and reasonable for that market. Because of this, the seller credit could cover fees that fit into that description, including inspection repairs or replacements. However, lenders usually cap the amount of fees a seller can credit a buyer between 3% and 9% of the loan amount.
Now, in a case where a seller agrees to give the buyer funds to repair or replace an item, they can’t just hand a bag of cash across the table at closing. There are several options. One is that the money can be rolled into a sellers credit term. Repairs can be made before or after closing but if the seller makes the repairs before closing, the buyer should take the home inspector back for a recheck as soon as possible. However, there are some scenarios where repairs can be made after closing.
Credit at Closing
The seller can give the buyer a lump sum at closing to cover the cost of repairs, which the buyer agrees to carry out. The seller can also prepay a contractor to do the work. Or, a portion of the sellers proceeds could be held in trust after closing and used for the repairs. The method usually depends on the complexity of the repairs and negotiations. Simple items should be taken care of before closing at the expense of the seller but extensive repairs should be quoted beforehand and agreed upon before closing.
Seller credits to the buyer
Seller credits can benefit both buyers and the sellers as sellers may offer buyers an incentive with the seller credit and buyers can reduce their out-of-pocket costs. For low down payment or even no down payment buyers, they can request a seller credit and increase the sales price to cover those costs, if the appraisal covers the inflated cost.
The type of credit that a seller can give to a buyer depends on the buyers financing. Their lender may not allow for seller credit and may require the repairs done prior to closing. To get around this, the credit may be in the form of a closing cost credit and there are limits. For an FHA mortgage, the seller can pay up to 6% of the sales price of the closing cost credit for the buyer. On conventional mortgages with a 5% to just under 10% down payment, the seller can credit up to 3% and on a 10% to nearly 25% down payment, the seller can credit up to 6% closing cost credit. The amounts go up depending on the down payment, so the lender will need to be careful not to exceed the actual amount of closing costs.
Although this is not specifically designed for the roof repair, it can be credited back towards the buyer at closing technically set up as giving funds to the buyer for repairs of the roof.
This is not uncommon for a seller to offer a dollar amount to the buyer in lieu of making repairs. It could simply be that the seller can’t afford the repairs, doesn’t want to deal with it, or the buyer has multiple issues that need to be taken care of by several repairmen.
The most preferred approach is for the seller to offer to pay the buyers closing costs up to the amount of the repair. This will reduce the funds the buyer needs to bring to closing and any savings are set aside to make the repairs after closing. The buyer and seller need to sign an addendum, which will state that the seller agrees to credit the buyer a certain amount at closing. This addendum is added to the contract and covers the amount agreed to in lieu of the seller making repairs themselves.
This might sound simple but it does require negotiation, as with any change to a purchase and sale contract. Buyers typically have five days to respond to inspection requests and buyers have five days from the receipt of the seller’s response to make a decision. Terms can be worked out in advance by both the buyer and the selling agent. Any decision needs to be agreed upon in writing and signed off by all parties involved. From here, escrow can take it and carry out instructions on how to disperse funds.
Reduce the Price
Another option is for the seller to simply reduce the price of the house itself. Let’s say the home has an accepted price of $400,000 but the quote on the roof repair is $10,000. The seller can either reduce the price of the house to $390,000 or negotiate to split the cost with the buyer. The appraisal will still need to come in at the dollar amount, but because we are lowering the price, this gives the buyer a little more wiggle room to make the repairs after closing.
What if the repairs cannot be made?
This might happen if the home is in a location where it is covered by snow for months at a time and roof repairs just simply cannot be made during that time of year. In this case, a roofer can offer a roofing certificate, which guarantees the roof for a minimum of five years, which a lender requires. Again, this may not even be possible and in this case, a home warranty might cover the repairs when or if needed, however, the lender needs to approve this as well.
Another option, although it’s fairly uncommon, is for the buyer to get a rehab loan. If the property sold for $300,000 but needs $50,000 in repairs, the lender may offer an entire loan of $350,000 with $50,000 of those funds set aside in escrow to make repairs. The repair payments are written directly from the escrow account as this protects the lender’s investment. The buyer must use those funds to improve the property and funds can only be dispersed by the escrow agent.
The biggest takeaway is communication. All parties must understand what’s happening and have every detail in writing and approved with initials or signatures. Moving money around, offering credits and incentives can get creative but regardless, lenders, escrow parties, agents and buyers and sellers must agree in writing and understand clearly what the process should be.