Disclaimer: As a friendly reminder, information in this blog post is meant to be used as a helpful guide and for educational purposes only, not legal or professional tax advice. For guidance on your individual situation, please consult a skilled lawyer or CPA.
You’ll find a ton of real estate advice out there about why buyers prefer closing cost credits vs. price reductions when they make an offer. A credit at closing gives buyers immediate savings on escrow and lender fees, whereas a price reduction must be realized over the course of what’s usually a 15- or 30-year loan.
Many sources online also claim that it’s all the same to the seller: a $5,000 price reduction and a $5,000 credit result in the same cash inflow for the person selling their home. However, we spoke with top listing agents and determined that what’s nice for the buyer could actually work against the seller:
“If all things are equal on the offers, it’s generally in the best interest of the seller to accept an offer with a lower price than it is to accept an offer with a higher price and a closing costs credit,” says top-selling Antioch, California listing agent Rick Fuller. “Oftentimes a price reduction offer will save the seller money in the end.”
Here we’ll dig into the details on how your sale price affects your closing costs as a seller, how to account for your potential tax liability, and why you should also weigh the risk of a low appraisal.
4 reasons a price reduction wins
Let’s start with an example.
Say you list your home for $250,000 and receive two different offers:
Offer A: The buyer will offer you $250,000 with a request for a $5,000 closing cost credit.
Offer B: The buyer will offer you $245,000 without a request for a closing cost credit.
With Offer A, you’re receiving a higher amount of funds from the buyer, but giving up $5,000 in cash at closing through the credit offered. With Offer B, you’re receiving fewer funds at closing from the buyer, but you also won’t need to cut a check at closing for that $5,000 credit. In either case, you receive $245,000 at closing, so what’s the difference to you, right?
While both offers look equal on the surface, there are other reasons why the price reduction wins for the seller:
1. A lower sales price reduces your selling fees.
Many of the fees you’ll pay when you sell your home will be calculated as a percentage of your sale price. That means the lower the sale price, the less (generally) you’ll pay in fees.
Take a look at your agent’s commission. The national average commission rate is 5.8%. Calculating from Offer A with a $250,000 purchase price, the commission owed would average $14,500. If you accept the second offer, the commission owed would average $14,210. That’s a savings of $290.
And don’t forget that other fees may be calculated as a percentage of the sale, including escrow fees, title fees, and transfer taxes. Many transfer tax fees will rise with each additional $500-$1,000 of property value.
Some states will trigger extra costs when the purchase price exceeds a certain threshold. For example, Connecticut charges 1.25% in taxes on any portion of home value above $800,000. All in all these additional (non-commission) costs do add up and usually cost the seller another 2%-4% of the sale price at closing.
2. You potentially reduce the taxable portion of the capital gain on your home sale.
If the cash you plan to pocket from your home sale pushes you over the threshold for the capital gains tax exemption, accepting a price reduction rather than a closing cost credit may reduce the taxable portion of your gain.
To calculate your capital gains, you would take the sale price of the home minus selling fees, subtract your adjusted cost basis (i.e., the original price of the home plus capital improvements), and the resulting number is what the government views as your “gain.”
If that gain is lower than $250,000 for single filers or $500,000 for married taxpayers filing jointly, and you meet the use and ownership tests, then you don’t owe capital gains up to those thresholds. If you exceed that exemption threshold, however, you’ll either need to pay short term capital gains, taxed as ordinary income, or long term capital gains, taxed at the graduated thresholds of 0%, 15%, or 20%.
If you’ve owned the home for a year or less, you’ll owe short term capital gains. If you owned the home for longer than that, you’ll qualify for the long-term capital gains rate.
But in essence, depending on a multitude of factors, a higher sale price with a closing cost credit could either push you over the exemption threshold, or it could increase the amount of your gain — thereby increasing your taxes owed on the sale. When in doubt, talk to a skilled CPA about the tax ramifications of your decision.
3. Your buyer could be on shaky financial ground.
When a buyer makes a request for a closing cost credit, this can sometimes be a red flag that they’re stretching their financial means. This isn’t always the case — some buyers could just be using a closing cost credit request as a negotiation tactic. And who doesn’t like to save money at closing?
However, it is a potential risk when a buyer asks for a credit that their savings are thin and it’s not guaranteed that they can cobble together enough funds to close.
“It’s most often used with buyers that have very little available liquid cash, or they want to direct their savings account to the down payment rather than to closing costs,” explains Fuller.
“If a buyer is asking for a closing costs credit, the seller may want to look at the buyer’s finances to determine whether or not they have the liquidity to complete the transaction.”
4. Risk of a low appraisal
Let’s say you’ve listed your home at the higher end of its value range. Now a buyer comes in and bids over-asking in exchange for a closing cost credit. This type of scenario can lead to trouble with the home appraisal.
A lender is only going to finance a home up to its appraised value. If an appraiser deems a home to be worth less than the price agreed on in the contract, the buyer and seller will have to make up the difference funds somehow.
“Low appraisals are a real problem because real estate values have been appreciating across the country for several years,” says Fuller.
“When an appraiser finds other properties that have sold six months ago, they’re almost always at a lesser sales price than what a buyer is willing to pay for a home in today’s market.”
While you may be netting the same proceeds with Offer A and Offer B, on paper Offer A has a higher sales price of $250,000 — which means that your buyer has to get a loan approved at that higher value. If the appraisal comes in lower than the sales price, the credits will not factor into the loan approval.
My house isn’t selling: Should I offer a closing cost credit or a price reduction?
Usually, it’s the smarter play for sellers to accept a price reduction over a closing cost credit. But what if your house isn’t selling?
Deciding which option is better often depends on price brackets. Research shows that over 90% of home buyers use online resources as part of their home searches, and online listing search engines use filters to narrow down results.
When to lower your price
Price brackets are one of the primary filters used by buyers to find potential properties. These brackets are generally divided by $50,000 to $100,000 increments. Changing your list price is a wise idea if it’ll land your listing into a new price bracket.
For example, let’s say that your home listed for $255,000 isn’t selling. A $5,000 closing cost credit isn’t going to move the needle much because your list price still remains at $255,000, which is just outside the $250,000 bracket.
In this scenario, it’s better to reduce your price by $5,000 rather than offering a $5,000 closing cost credit. A price reduction that puts you in a new bracket opens your listing up to a whole new pool of buyers. And in the end, your take home proceeds will be exactly the same.
When to offer a credit instead
But there’s another scenario to consider: “If you’re not on the edge of a bracket, it’s oftentimes wiser to offer a $5,000 credit to attract buyers rather than to make a price adjustment,” advises Fuller.
When you reduce the price, some buyers consider that to be a red flag about the quality of the home. A closing cost credit can feel more like an incentive or bonus — like throwing in the pool table or sectional sofa. And for the reasons we discussed before, buyers appreciate credits for their immediate savings at closing. Think about it: the money a buyer saves on escrow and lender fees can instead go toward furnishing their new home.
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