Can a Seller Pay Closing Costs on an FHA Loan?
Navigate FHA financing with insights into seller contributions. Optimize your home purchase strategy and reduce out-of-pocket expenses.
The Federal Housing Administration (FHA) loan program helps many achieve homeownership. These loans make financing more accessible by providing government insurance to lenders, encouraging favorable terms. For homebuyers, especially those with limited savings, understanding how various parties can assist with purchase costs is beneficial.
Understanding Closing Costs in FHA Transactions
Closing costs are fees and expenses incurred to finalize a real estate transaction. For FHA loans, these costs typically range from 2% to 6% of the purchase price. They are separate from the down payment, which is the portion of the home’s price paid upfront.
Common FHA closing costs include lender fees, such as origination and underwriting fees for processing the loan. Other expenses include third-party services like appraisal fees and credit report fees. Buyers also encounter title insurance, escrow fees, recording fees, and prepaid items like initial property taxes and homeowner’s insurance premiums. A distinct FHA closing cost is the upfront mortgage insurance premium (UFMIP), which is 1.75% of the loan amount and is generally financed into the loan or paid at closing.
FHA Guidelines for Seller Contributions
The FHA sets specific rules for seller contributions towards a buyer’s closing costs in an FHA loan transaction. Sellers and other interested parties can contribute up to 6% of the lesser of the sales price or appraised value of the property. This limit aims to prevent inflated property values due to excessive concessions. If contributions exceed this 6% cap, the FHA will reduce the loan amount dollar-for-dollar for any amount over the limit.
Seller contributions can cover a range of eligible expenses, significantly reducing the cash a buyer needs at closing. These often include loan origination fees, discount points to lower the interest rate, appraisal and inspection fees, and title insurance. Prepaid expenses such as property taxes and homeowner’s insurance premiums are also permissible. These contributions are considered concessions and do not reduce the actual sales price of the home.
However, there are specific items that seller contributions cannot cover. The down payment, which is a minimum of 3.5% for FHA loans, cannot be funded by the seller. Sellers are also prohibited from giving cash back to the buyer or covering costs that exceed the FHA’s 6% limit. Contributions should directly apply to legitimate closing costs and not be used for other purposes like paying off the buyer’s debts or for repairs beyond FHA-required fixes.
Applying Seller Contributions to Your Loan
Seller contributions reduce the buyer’s out-of-pocket expenses at closing. These contributions are not given as cash directly to the buyer but are applied as a credit on the official loan documents. The process begins with negotiation between the buyer and seller, where the agreed-upon seller contribution is specified in the purchase contract.
This financial assistance from the seller is reflected on key mortgage documents, such as the Loan Estimate and the Closing Disclosure. The Loan Estimate, provided early in the process, summarizes loan terms and estimated costs, including any seller credits. The Closing Disclosure, provided at least three business days before closing, details all final costs and credits.
On these documents, seller contributions appear as a credit, effectively lowering the “cash to close” amount that the buyer must bring to the settlement table. For example, if a buyer’s closing costs total $10,000 and the seller contributes $5,000, the buyer’s cash needed at closing is reduced by that $5,000. This mechanism ensures that the funds directly offset specific costs rather than being disbursed as cash to the buyer.