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My agent advised me that its common to get a 3% cash concession from the seller when purchasing a home to cover closing costs. I want to know what negative affects this might have by taking cash in lieu of lowering the purchase price by the same amount? That would mean 100k price and getting a 3k refund vs straight 97k purchase price.

Assume that down payment is 20% of purchase price in both cases.

The only difference I am aware of, is slight increase in closing costs (since the loan is larger), and the associated larger monthly payment. Are there any other downsides? For example:

  • Are there restrictions on what the concession amount must be spent on?
  • Is there a requirement to return unspent concession to the seller?
  • Is the concession a taxable gain by the IRS?

If one does not need the concession to purchase a home, is it better to simply purchase for the equivalent price without the concession?

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You're basically asking for a lower price. Ask, the worst they do is say "no". –  JoeTaxpayer Jan 13 '12 at 3:42
    
Sorry, I'm not asking this. I'll try to rephrase to make it more clear. –  Casey Jan 13 '12 at 4:34
    
Are you buying new or used? Many builders want to keep their price per square foot up so they would rather give you some upgrades and pay for some closing costs then to drop the sale price. –  Kellenjb Jan 14 '12 at 19:59
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5 Answers

I found this article to clarify some of the issues. One point raised is that the concession can be thought of as getting tax exemption for the closing costs, which normally are not allow. I'm not sure I follow this logic, since you can only deduct the interest, not the principal.

I asked a lender, and he verified you can only spend the concession money on closing costs. I think if your closing costs are less than 1% of the loan, its probably not worth it to go for a concession over the price reduction.

With interest rates so low, its also not cost effective to buy down points on the loan. This should limit most of your closing costs.

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A lower price is likely to be slightly more attractive to sellers than paying an equivalent amount in closing costs. The seller is going to be paying the realtor(s) commission on the higher "sale" price and will net slightly less money. It is common in my experience to ask for closing costs.

The generic answer for your questions about how it is spent depends on the bank and type of loan. In general you will not be able to walk away with the cash if closing costs are less than the concession but they can be applied to funding escrow and points transfer fees etc.. There is the potential to lose the concession if there aren't sufficient closing costs.

I am fairly certain that there isn't any tax differences between the two in the US.

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I can't think of any more negatives apart from what you mentioned, but the positives might include higher cost base for when you sell the place (this only applies in Australia if it is an investment property) thus having to pay less tax on the capital gains, and being able to borrowing extra funds which may help with your cashflow (especially if you keep the extra funds in an 100% offset account so your interest payable is not increased until you really need the extra funds).

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The only downside is for the agents, not you.

Agents, especially selling agents, prefer the concession over the price reduction for their own interests. They get a commission on a higher purchase price. That, and the recorded sales price for the house is a tad higher, which incrementally increases the comps for the next sales.

When we moved, the agent conditioned me to get ready to offer a concession should we decide to sell our previous home. We decided to rent that property, and have someone else manage it.

But with regard to your questions, the concessions are applied against your closing costs. When we bought our last house they specified caps on the closing costs, so money will be typically be withheld (or not) contractually.

The concessions aren't a taxable gain. Your basis in the property will be higher than if you get a price reduction, but the lower basis (hopefully) means a higher capital gain when you sell.

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There are ups and downs to doing this.

This isn't a taxable gain, because it's borrowed money that will be repaid. Whether there are restrictions or not depends upon your contract with the seller and your bank. If the concessions are for health & safety related repairs, your bank may require you to complete the work before closing or within a certain period of time.

Overall:

Upsides

  • You get to "cash out" money that you borrowed in the mortgage.
  • You get to make repairs or modifications to the property with the sellers money, while controlling the work.
  • If you need to raise additional funds to cover the down payment, you won't affect the underwriting of the mortgage by borrowing funds from a bank, credit card, etc.

Downsides

  • In states like New York with a mortgage tax, you'll pay more.
  • The real estate agent's commission is based on the gross selling price, so you pay more.
  • Many jurisdictions will use the higher selling price as the basis for your tax assessment. If it's 3%, that isn't that big of a deal... but for our last house we received a 15% concession, which required me to contest my tax assessment.
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