What Is a Credit When Buying a House?
Understand how credits work when buying a house to reduce your out-of-pocket expenses and navigate closing costs effectively.
When purchasing a home, understanding the financial terminology is important for managing costs. In real estate transactions, a “credit” refers to an amount of money that reduces the buyer’s out-of-pocket expenses at the time of closing. These credits lower the total cash a buyer needs to bring to the settlement table, rather than directly reducing the purchase price of the home itself. This financial adjustment helps make homeownership more accessible by offsetting fees and charges associated with completing the transaction.
Understanding Different Types of Credits
Credits in a home purchase originate from different parties. A seller credit is when the home seller pays a portion of the buyer’s closing costs. Sellers offer these to incentivize a sale, especially if the home needs minor repairs or to help a buyer with limited upfront cash. These credits are negotiated in the purchase agreement and are often capped at a percentage of the loan amount or sale price.
Lender credits are offered by the mortgage lender. Lenders provide these in exchange for a slightly higher interest rate on the loan. This helps the borrower cover closing costs, reducing the cash needed at settlement. This can be an option for buyers who prefer to finance more upfront expenses over the loan’s life.
New home builders offer builder credits, especially in new construction communities. These incentives encourage buyers to purchase a property or use the builder’s preferred lender or title company. Builder credits can apply towards upgrades, closing costs, or a reduction in the home’s price, depending on the builder’s program. For example, a builder might offer a credit if a buyer uses their in-house mortgage company.
Property tax credits may be available in some areas, though they are less common as direct closing credits and more often relate to ongoing tax relief. These can appear as prorated adjustments at closing, where the seller credits for property taxes paid or owed. This ensures the buyer and seller each pay their share of property taxes for the portion of the year they owned the home.
The Application of Credits to Your Home Purchase
Credits reduce the cash a buyer needs at closing. They are applied against transaction-related expenses, not as a discount on the home’s sale price. While the purchase price remains the same, the buyer’s immediate cash outflow is lessened. This helps homebuyers, especially first-time buyers, with limited savings for closing costs.
Credits commonly offset closing costs, which are fees associated with finalizing a mortgage loan and real estate transaction. These include loan origination fees, appraisal fees, title insurance premiums, attorney fees, and recording fees. Credits can also apply to prepaid expenses, such as escrow deposits for property taxes and homeowner’s insurance premiums. For example, a $5,000 seller credit could cover a portion of the loan origination fee and the first year’s homeowner’s insurance premium.
Credit application is documented on official forms. The Loan Estimate, provided after applying for a mortgage, shows estimated credits in the “Other Costs” section, reducing the “Cash to Close” estimate. The Closing Disclosure, received at least three business days before closing, provides the final, itemized breakdown of all costs and credits. This document shows how credits apply to specific line items, reducing the final cash amount the buyer must bring to settlement.
If a buyer’s total closing costs and prepaids are $10,000 and they receive a $5,000 credit, their cash to close would be reduced to $5,000 plus their down payment. Credits are not disbursed as cash to the buyer but reduce the total amount due from the buyer at settlement.
Important Limitations and Documentation of Credits
Credits have limitations on the amounts buyers can receive. These limits depend on the loan type (e.g., Conventional, FHA, VA) and the percentage of the purchase price or loan amount. For Conventional loans, seller contributions towards closing costs are capped at 3% to 9% of the sales price, depending on the buyer’s down payment. FHA loans allow seller contributions up to 6% of the sales price, while VA loans permit up to 4% for certain fees and charges.
Credits cannot be used to cover the down payment. The down payment is a separate equity contribution required by the lender and is not a closing cost or prepaid item. Using a credit for a down payment would violate lending guidelines and could jeopardize loan approval. These limits ensure buyers have a financial stake in the property.
Credits do not reduce the actual loan amount or directly impact the home’s appraised value. The loan amount is based on the agreed-upon purchase price and the buyer’s down payment. The appraisal determines the property’s market value. Credits are applied at closing to offset fees, not to decrease the mortgage’s principal balance.
Proper documentation ensures agreed-upon credits are accurately applied. All credits must be itemized in the purchase agreement (sales contract) signed by both buyer and seller. This document serves as the primary record. Credits must also appear on the Loan Estimate and the final Closing Disclosure. Buyers should review these documents to confirm all negotiated credits are present and correctly allocated, ensuring a smooth financial settlement.