People get hung up on all kinds of things during a real estate transaction. Preconceived notions of good and bad often blind people from the bigger picture, and emotion almost always runs amok.
Home sellers often ask me, “Why should I pay for the buyer’s closings costs?” I most often hear this from members of the older generations, people who had to save up large down payments before they bought their first home. “If a person can’t pay their own closing costs then they have no business buying a home,” one gentleman recently told me.
Why do you want to pay for the buyer’s closing costs? Because paying your home buyer’s closing costs could mean selling your home faster and putting more money in your pocket. That’s all.
I’m not saying that paying your buyer’s closings costs is a must. Suppose you get two offers on your home for $500,000. If one offer is asking for $15,000 in closing help and the other is asking for zero in closing help, then it’s a no brainer. You go with the highest net to you. But that’s the key right there. Your goal is to get the highest net price you can.
There are very few absolute rules in real estate. This is the only one I can think of: Maximize your net is the name of the game. It may seem unfair or it may sound counterintuitive that paying your buyer’s closing costs can increase your net, but it just might.
Offering or at least being willing to pay your buyer’s closing costs increases the number of potential buyers for your home. There are a lot of home shoppers out there who are struggling to come up with down payment, moving costs and closing costs. Offering or at least being willing to help with closing costs could increase your potential buyer pool by 25 percent or more depending on your location.
More potential buyers equals more competition, which leads to a faster sale and possibly a higher price.
As always, look closely at your local market. If you live in a hot area where prices are climbing, inventory is low and competition is intense, then you might be crazy to pick up someone’s closing costs. In other areas, paying buyer’s closing costs might be an absolute must. And then there’s a whole bunch of areas that fall somewhere in between.
You’ll see this when you look at the recent comparable sales in your neighborhood. If your neighborhood is attracting young families shopping for their first home, then the comparable sales data might show that all your neighbors are paying closing costs when they sell. If you live in an area similar to this, then your unwillingness to help with a buyer’s closing expenses could cost you thousands of dollars.
There are some neighborhoods in and around Washington that I know before going in that my buyers are most likely going to have FHA loans and are going to need closing help. I budget this in when I buy the home. Imagine you refuse to help with closing costs in an area where most buyers need closing help. You’ve effectively eliminated all of the retail buyers, and the only buyers who can come up with the necessary cash are real estate investors. The most generous — or crazy — real estate investor will not want to pay more than 80 to 90 percent of a home’s value. So, in this example, you can either discount your home by 10 percent to deal only with those people who have cash for down payment and closing costs, or you can offer up to 3 percent of the home’s sales price in closing costs help to your buyers. In this example, that flexibility will have just made you an additional 7 percent or $7,000 for every $100,000 of home value. Would you give $3 to make $10?
Even if you’re in an area where some buyers have plenty of cash on hand, you might find that those buyers can still be hard to please. They may not be looking for the discount that a real estate investor is seeking, but they often want to get a better deal because they know they’re stronger buyers.
Cash is king, but many people seem to put a very strong premium on closing costs. They seem to think that $1 in closing costs is worth $2 in purchase price.
I was recently listing a home in a neighborhood that is a perfect example. It’s not a starter home community; it’s probably what you might consider a move-up community, but sellers still need to put in some effort to get their home sold. I looked at the comparable sales in the neighborhood and found that six homes sold in the past year. Three of those homes sold in the $440,000 range and they paid $10,000 to $15,000 in buyer’s closing costs. There were three other homes that sold for $400,000 to $410,000 and they paid no closing at all. The people who paid closing put an extra $10,000 to $15,000 in their pockets. Now, that’s a very anecdotal example. There are a thousand different reasons as to why those homes sold at their specific closing prices, but I did find it to be very interesting.
While I was listing that home I held an open house. A young man showed up and we started talking about what he wanted in his next home. He told me he had a loan preapproval in hand, he didn’t need any closing help and he was looking for a great deal first and foremost.
I was listing that home for $445,000. A man scheduled an appointment with me to view the home. After touring the home, he made us an offer that went something like this: He would pay $430,000 with $10,000 in closing assistance or he would pay $410,000 and he would pay all of his own closing costs. I have no idea why he came up with those numbers. We rejected the offer. In the end, we got our asking price and we ended up paying about $12,000 toward the buyer’s closing costs.
You’re still hung up on closing costs? You just don’t think it’s right to pay someone else’s closing costs because you bought your first home in the early 1980s? You had to come up with your own closing costs, plus a large down payment, and you had to pay 12 percent or more interest?
That’s a valid point. But you might also consider that the younger generation is certainly dealing with some daunting burdens. The increase in home prices has been far outpacing incomes for the past 30 years. I just did a little down and dirty research project. I looked at the Zip code 22207 in North Arlington. In 1996, it looks like the average detached home in that Zip code sold for about $311,000. The median income in Arlington County at that time was about $50,000. Last year, it looks like the average detached home sold for around $1.1 million, and the average income was right at about $103,000 in Arlington County, according to the Census Bureau. So 20 years ago, the average home price was about six times the average income, and now the average home seems to be selling at almost 11 times the average income.
North Arlington is an extreme example, but no matter where you look in the Washington area, home prices have significantly outpaced incomes.
Every generation has its challenges. The newer generation of home buyers do enjoy lower interest rates, but they also have to pay much higher prices for homes compared with their incomes. They carry way more college debt than any other generation before. Very few millennials or Gen Xers have company retirements, and medical expenses have never been higher for a young family.
There are plenty of reasons to feel good about giving a young home buyer a break. The best reason of all is that it just might put more money in your pocket.
Justin Pierce is a real estate investor and real estate agent who regularly writes about his experiences buying, renovating and selling houses in the Washington area.