Written by Robert H. Ruth
What is a concession?
A concession is some benefit usually offered from the seller to the buyer that helps in the negotiation to buy a home. The concession is typically financial in nature, and is in essence, a type of deal sweetener for the buyer. In the real estate finance industry, concessions are also known as Interested Party Contributions (IPC’s). For this article, I wanted to explain the 2 most common types of IPC’s: financing concessions, and sales concessions.
These IPC’s are paid on the borrower’s behalf by the seller to help facilitate the transaction. Financing Concessions typically cover closing costs for the buyer who is financing the purchase with a mortgage. They are payments made at the closing table by the seller, but the seller does not actually pay money in cash to the buyer. The concession is paid directly from the equity proceeds due to the seller at the closing. For example, if a house is being sold for $100,000, and the seller has a $70,000 mortgage balance, the equity to the seller would be $ 30,000. If the seller agreed to pay a financing concession for $5000 on behalf of the buyer, they would then net $25,000, not $30,000.
Financing concessions are usually the fees for closing costs and loan fees paid in connection with the buyer’s mortgage. These fees include:
- Origination fees
- Discount fees (points) used to get a lower rate for the loan term
- Appraisal and flood certification fees
- Credit report and tax service fees
- Attorney’s fees for title search and closing
- Title insurance costs for both lender and buyer
- Survey fees
- Recording fees and tax stamps
- Municipal Fees
Financing concessions can also include prepaid escrow items, such as:
- Prepaid Interest due at closing (which is limited to 30 days or less)
- Escrow impounds for the future payment of real estate taxes
- The initial homeowner’s insurance premium for the buyer
- Escrow impounds for the future renewal of homeowners insurance
- Homeowners association dues covering up to 12 months after closing
- Initial and/or renewal premiums for Private Mortgage Insurance (PMI)
There are limits on the amount a seller can contribute for these items. For a Conventional Fannie Mae or Freddie Mac Mortgage, the limits are based upon the LTV ratio for the transaction. Here is a table showing the maximum limits by LTV ratio:
|Owner Occupied & Second Home||Investment:|
|90.01% & Above: 3%||All CLTV’s: 2%|
|75.01% - 90.00%: 6%|
|75.00% & Below: 9%|
Based upon the above, if a buyer is putting 5% down and seeking a mortgage for $285,000, the maximum seller concession would be 3% of the loan amount, or $8,550. On a $285,000 loan, this amount will likely cover closing costs and most, if not all, of the buyer’s prepaid escrow items at closing.
Similarly, if a buyer is getting a mortgage for $350,000 which is 80% of the value (20% down) the maximum seller concession would be $ 21,000, which is 6% of the loan amount. In New England, it is not at all likely that the closing costs would come anywhere near this amount, so you could make up some of the difference using points to get a lower rate on the loan.
For example, if the closing costs and prepaid escrow items are $10,000, and 2 points are $3500 each ( each point is equal to 1% of the loan amount), the total financing concession would be $17,000 ( $10,000 + $7000) = $17,000, or a financing concession of 4.86%
If the loan product allows funds to be provided by a non-profit organization, they are also subject to these same LTV limitations.
Sales concessions are IPC’s that take the form of non-realty items. These include:
- Furniture or other personal items, also known as chattel
- Decorating allowances
- Moving Costs
- Any other financing concession that exceeds the Fannie Mae or Freddie Mac limits above.
Sales concessions are different from financing concessions in that sales concessions typically are viewed as an inducement by the seller to facilitate a purchase. Consequently, the value of sales concessions must be deducted from the sales price when calculating the LTV ratio for the loan.
For example, if you are buying a waterfront vacation home and the sales contract states that the sale will include 2 Jet Skis, an old Jeep, and all the furniture, this would be an example of an inducement to purchase in the form of a sales concession. Therefore the value of these items would need to be determined, usually by an independent appraisal, and the dollar value deducted from the purchase price of the property.
Here is an example of how this sales concession might influence the transaction:
- Sales Price is $500,000
- Buyer is putting down 25% ($125,000) and seeking a loan for $ 375,000, a 75% LTV (Loan to Value Ratio).
- Most second homes require a 20% down payment for the mortgage, which is an 80 Loan to Value Ratio (LTV)
- The 2 jet skis, are valued at $8,000, and the furniture in the house and the Jeep is appraised at $52,000.
- Total amount of the sales concession is $8,000+ $52,000 = $60,000
- $60,000 represents 12% of the sales price.
- Value of the house would be reduced by $60,000 ( $500,000 - $60,000 = $ 440,000)
- A $375,000 loan divided by an adjusted sales price of $440,000 = a loan to value ratio of 85.32
- Based upon the adjusted LTV ratio at 85.32 %, the buyer would need Private Mortgage Insurance on their loan, and may not have enough equity for a vacation home purchase since their LTV exceeds 80%.
Based upon the above, you can see how important it is to completely understand the impact a sales concession may have upon the value of the property you are purchasing.
This is only an example of how IPC’s can influence a Real Estate transaction. The best advice I can give you is to negotiate carefully on any home purchase, and unless you have a really large down payment, do not be swayed by sales concessions designed to make the house more attractive to potential buyers.
ROBERT RUTH Senior Mortgage Banker
c: 401.789.4441 | email@example.com