What are Buyer's Closing Costs and Prepaid Items

Question

Hi All,

A friend of mine recently signed an offer to purchase a home. The seller agreed to the following terms: Seller will contribute to $X towards the buyer's closing costs and/or prepaid items.

I told him that this was likely not a simple credit of $X but rather that that the seller would pay up to $X for closing costs and/or prepaid items. If so, he would like to know what would be considered as closing costs (for instance, closing costs typically include a reserve for taxes, or origination points?) and what are "prepaid items".

Any help would be appreciated. thank you!!

Rick Lucette · Answer

Yup. Didn't see it from that angle. But makes sense. It's just that it would seem premature for the seller to explore that option unless the buyer specifically mention their budget is tight. In the case of my friend, they could come up with the down payment but the negotiation started to go in all sort of directions that didn't make much sense to me.

Ben Wilkins · Answer

@Rick Lucette - good question.

This is how I always looked at it, but I could be wrong:

If the buyer cannot afford the closing costs, the seller would have to lower the sale price significantly. The only thing that happens by lowering sale cost is that the 20% down payment goes down. Assuming the buyer is putting down 20%, the sale price would have to go down quite a bit for the buyer to get 20% plus closing costs.

Let's say closing costs are $10k for a nice round number

Price of the property is $200k, so 20% is $40k. Let's assume the buyer only has $40k

In this situation, the seller would have to lower the cost down to $150k for the buyer to pay $30k down payment plus $10k for closing costs (total of $40k)

It makes more sense usually in this case for the seller to cover the closing costs (or usually a portion of them)

Rick Lucette · Answer

Thanks guys! this was super helpful. Just out of curiosity, what's the incentive for a seller to pay for closing costs rather than lower the selling price. I would think lowering the sale price would reduce your appreciation gains? And lower the taxes for the buyer? I'm just surprised people would negotiate on these.

Thanks!

Ben Wilkins · Answer

@Rick Lucette - closing costs generally include appraisal and inspection fees as well.

Other than that, @Jd Martin seems to have it covered.

JD Martin · Answer

Prepaid items usually include things like property taxes, HOA fees, etc. Items that are the financial responsibility of the property owner. There's typical a pro-rating of these types of things. For example, if you were closing on July 1, the seller is responsible for half of this year's property taxes, even though they won't be collected until next year (or whenever, depends on where you are). So, for example, where I am, I would get a credit for 6 months of property taxes at whatever the current rate is, and that comes off of my total funds due.

Closing costs are going to be your finance costs (if any), title work, deed registration, surveying, legal fees, etc.