Which is better, a Price Cut or Closing Cost Credit?
Often times in tough markets, Sellers will offer Closing Cost Credits to entice a Buyer to offer on their home. But in reality, a Price Reduction maybe the better option.
So to answer the question, “Which is better, a Price Cut or Closing Cost Credit?” we first must look at which perspective we’re speaking from; a Buyer or Seller, and ultimately, what their goals are.
SEller
From a Seller Perspective:
As a Seller, it might be better to offer a Price Reduction than a Closing Credit. Many people suggest that $5,000 off the Sales Price and $5,000 credit have the same effect. However that is rarely the case; a Price Reduction will likely save the Seller money in the long run.
Buyer
From a Buyer Perspective:
Depending on the Buyer’s situation and goals, a Price Reduction may be more beneficial over the long run, but a Closing Credit will help with immediate cash flow.
SELLER
Property Price Reduction
Let’s look at an Example:
You list at $250,000 and receive two offers:
- A. $250,000 with a request for $5,000 closing cost credit.
- B. $245,000 without closing cost assistance.
In either case you receive $245,000 at closing, but actually – there’s more to it.
If you accepted Offer B.) there are some significant potential benefits and savings.
Reduced Overall Selling Fees
Many of the fees associated with Selling a Property are a percentage of the Sales Price. Title Escrow Fees, Transfer Tax and likely, the Real Estate Commissions to be paid are all based off the Sales Price.
From our example at $250,000; 1% Escrow fee is $2,500. (Hypothetically,) the real estate commission charged is 2.5% =$6,250. ($8,750 total)
At $245,000; 1% is $2,450 and commission is $6,125. ($8,575)
$175 Savings by lowering the price rather than offering a credit.
Evaluate the Buyers Situation
Many Buyers need Closing Cost assistance to make a deal happen. Often, there’s just no way around it.
But needing significant assistance may indicate a red-flag that the transaction may not close down the road anyhow.
Risk of a Low Appraisal
Let’s say we list your home at the higher end of the value range. A Buyer comes in and further over-bids on the property but asks for a Cost Concession to help offset that amount. You’re ecstatic because you got a fantastic offer. But, wait there might be more to it. The lender is only going to finance a home up to it’s appraisal value. If that appraisal comes in lower than the offer price the lender will not loan over the appraisal amount. So now what, well, the Buyer is asking for a price reduction and a cost concession.
Additional Potential Buyer Pool
Assuming we list your house at ~$515k. We haven’t gotten any offers so we’re now discussing a price cut (or credit).
It does you no good to lower to $510k or $505k. And here’s why. We haven’t added any potential Buyers to the pool. At $500k, now we have access to Buyers with purchasing power up to $500k.
In a highly competitive market it is sometimes better to be the bigger fish in a smaller pond.
More About Price Cuts
In the previous example we discussed resisting the urge to price drop $5k or $10k increments. In Competitive Markets, Buyers seem to have all the time in the world – they will wait you out to see if you continue negotiating against yourself.
Reduced Capital Gains Tax
If you plan to pocket the cash from the sale of your property, you can reduce the taxable portion of your “gain”. When it comes time to file your taxes, if the proceeds from the sale of the home were over a $250k for single people and $500k married people, you will have to pay taxes on that additional amount.
Consider for a moment, if you sold a house for $775,000 and gave the Buyer a Credit of $15,000. Hypothetically speaking you now have a Taxable Capital Gain of $125,000. Had you not offered the credit and instead lowered the sales price, your Taxable Capital Gain would have been $110,000. So basically, you’re paying tax on the credit you offered the Buyer.
Consult your Tax Professional for assistance and information on Capital Gains.
Buyer
Closing Cost Credit: Buyer Assistance Credit
Requesting a Closing Cost Credit will ease the immediate cash flow crunch. Basically you’ll have to bring less cash to the table at closing for costs such as real estate commission fees, prorated fees, and loan origination costs.
That’s always cool.
Buyer
Lower Offer and Sales Price
Your overall interest liability in the home will be reduced if you can come in with a lower Sales price, rather than accept a Closing Cost Credit.
Here me out.
If you take a loan at $250,000 at 6.25% interest in the first year alone, you will pay $15,625 in interest. A loan at $245,000 at 6.25% interest is $15,312.50.
That’s a Savings of $312.5 the very first year you own the home. The impact only grows the longer you keep the home.
We always, highly, strongly and urgently encourage Buyers to pay as much as they can toward the principal payment of their mortgage, especially in the early years of the mortgage.
Not accounting for taxes or insurance, your payment is calculated
principal x interest = payment due
The lesser that principal amount the lesser the interest due against it.
Assuming your mortgage does not have any pre-payment penalties.
Talk to your mortgage provider and tax professional about the benefits of making additional principal only payments.
Final Thoughts
Price Cuts and Closing Cost Credits
Every client’s situation is different and not all suggestions will work for everyone. Sometimes a closing cost credit is the only way to make a deal work.
Depending on the market and your goals there may be a combination of both elements. Find a Realtor you can trust to guide you though the process and ensure your goals are represented.