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Closing Cost Credits – Buyer Beware!

A simple contract term can cause so much confusion:

“Seller shall provide buyer with a closing cost credit of $3,000 at closing.”

Closing cost credits are often used to help buyers cover their costs or to address contract issues prior to closing. When Buyer’s and Sellers agree on this credit, everyone should be happy. Unfortunately, it is not that simple.

The buyer’s lender must approve all closing credits and they must appear on the HUD-1 Settlement Statement. Problems arise when lenders reject these credits.

Contract Language and Communication

Realtors must draft good contract language and communicate with their Buyers. First, Realtors may provide for a “closing cost and prepaid” credit. Lenders will only allow credits up to the amount of the Buyer’s actual closing costs. Including “prepaids” allows many lenders to increase the allowable credits to include prepaid mortgage interest and tax escrows. Realtors should also avoid excessively large closing cost credits. In Dane County, for instance, it is unusual for closing costs to exceed $3,500. A closing cost credit of $8,000 is virtually certain to be denied. It is also important to communicate with your Buyers and warn them that the closing cost credit requires lender approval. Prepare them for the possibility that the credit may be limited or even rejected.

Avoiding Lender Rejection of Credits

Many Realtors or attorneys include provisions that reduce the purchase price by the amount of any rejected credits. Beware: this can cause delays and the need to re-underwrite a loan. The seller may also credit “prepaid” items to increase the allowable credits. Check with the lender prior to drafting the “closing cost and prepaid credit” provision to make sure it is acceptable. The best practice is to avoid closing cost credits that exceed actual closing costs.

Most importantly, if a lender rejects a credit, there are certain things that are not acceptable:

  • Do NOT have the Seller write a personal check to the Buyer at closing
  • Do NOT ask the title company to write a check to the buyer, and reduce the seller’s proceeds by that amount.
  • Do NOT have the Realtors write a check to the Buyers.

Each of these “solutions” may constitute loan fraud. It is never worth risking a Realtor’s license or an attorney’s practice to assist or instruct their clients in the commission of loan fraud (no matter how unlikely it may seem that there would be any real consequences).

This information is provided by attorney Pete Zarov. This is not intended to constitute legal advice and should not be relied upon in place of individualized legal advice. For more real estate tips, check out Homestead Title’s blog.

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