The Buyer’s Perspective on Closing Cost Credits versus Price Reductions

While you are negotiating your contract for purchase of real estate, or during your attorney and inspection review periods, you (the Buyer) may reach a point where you need to make a decision about a closing cost credit or a purchase price reduction. For some reason or other, you and the seller have agreed on a financial concession in your favor.  At this point, you need to decide how you should receive that concession.

If you are purchasing in cash, the simplest thing to do is to reduce the purchase price. Since you are a cash purchaser, you will be paying your purchase price and all of your closing cost at closing anyway. There is no lender involved to make things messy, so you might as well take a straight reduction on the purchase price. At some point when the county goes back and looks at the sale of the property, the lower purchase price could work a little bit in your favor in terms of real estate taxes also.  The less the value of the property, the less the taxes. Having said that, real estate taxes are calculated based on a variety of factors and property value is just one component.

On the other hand, if you are financing, you could do either a purchase price reduction or a closing cost credit. Whichever way you decide to go, the change will need to be documented for your lender.  So which option should you choose?  It depends.

Most people go with the closing cost credit. Let me explain why. Let’s say you were buying a home for $100,000 and putting 20% down.  Just for the sake of this example, let’s say your closing costs are $5000 and you are not getting any proration credits at closing. This means at closing you need to bring in $25,000, which is comprised of the 20% you are putting down, as well as the $5000 in closing costs.  Now, let’s say that your real estate agent or real estate attorney negotiate a closing cost credit of $3000 on your behalf.  That $3000 credit applies against the $25,000 you needed to bring in. Now, you only need to bring in $22,000 to the closing table.  By taking the closing cost credit, you have to put less money up front.  You could use this money for something else.

What if you had decided to go with the price reduction?  In that case, your purchase price would be reduced by the $3000 incentive. Your new purchase price would be $97,000. You still need to bring in 20% of that to close, which is $19,400.  You also still need to pay your $5000 in closing costs. Add that to your down payment, and you need to bring in $24,400 to the closing table.  While you need less than the original $25,000 down payment based on the $100,000 purchase price, it’s not that much less.  Many people prefer bringing in less money up front, which is why they go with the closing cost credit option.  In our example, you can bring in $2400 less money up front by choosing a closing cost credit over a purchase price reduction.

Keep in mind that lenders do have limits on closing cost credits. If you negotiate a particularly large concession, you may not be able to take it as a closing cost credit, or at least not all of it. In that case, a purchase price reduction would be the way to go. Alternatively, you may be able to take part of the concession as a closing cost credit and the rest as a purchase price reduction.

Of course, you don’t have to make these decisions in a vacuum. Your real estate attorney, your real estate agent, and your lender will all guide you to the right decision for you.  Do not hesitate to ask the professionals you are working with for guidance!