$10,000 Off the Price or $10,000 Toward Closing Costs: Which Saves More?

Suppose a home seller is willing to give you a $10,000 concession.

Would you rather have:

• $10,000 deducted from the purchase price?
• $10,000 paid toward your closing costs?
• $10,000 used to reduce your mortgage payment?

Most buyers instinctively choose the price reduction. Paying less for the house feels like the obvious way to save the most money.

But depending on your finances and how long you expect to keep the mortgage, that may not be the choice that helps you most.

On a typical financed purchase, taking $10,000 off the price may reduce the monthly principal-and-interest payment by only about $61. Using that same concession toward closing costs could reduce the cash you need at closing by as much as $10,000. A temporary mortgage-rate buydown could lower the payment by nearly $480 per month during the first year.

The best choice depends on the problem you are trying to solve.

Comparing the Same $10,000 Three Ways

Consider this example:

• Purchase price: $400,000
• Down payment: 5%
• Loan type: 30-year conventional mortgage
• Example interest rate: 6.625%
• Seller concession: $10,000

Without a seller concession, the buyer would make a $20,000 down payment and borrow $380,000.

The monthly principal-and-interest payment would be approximately $2,433. Property taxes, homeowners insurance, mortgage insurance and association fees are not included in this comparison.

Here is what happens when we apply the seller’s $10,000 in three different ways:

Each option has value. But they solve very different problems.

Option 1: Reduce the Purchase Price

If the seller reduces the price from $400,000 to $390,000, a buyer putting 5% down would borrow approximately $370,500 instead of $380,000.

At the same 6.625% interest rate, the monthly principal-and-interest payment would fall from approximately $2,433 to $2,372.

That is a monthly savings of about $61.

The required 5% down payment would also decrease from $20,000 to $19,500, saving another $500 at closing.

A price reduction provides a real, permanent benefit. The buyer begins with less debt and pays less interest for as long as the loan remains in place. If the buyer kept this mortgage for the full 30 years, the reduced loan balance would save approximately $12,399 in interest, in addition to eliminating $9,500 of borrowed principal.

However, many buyers sell or refinance long before making 360 payments. For those buyers, the long-term interest savings would be smaller.

A lower price may be the strongest choice when:

• There is concern the contract price may exceed the home’s appraised value.
• The buyer wants to minimize debt.
• The buyer expects to keep the mortgage for many years.
• The buyer has plenty of cash but wants the strongest long-term financial position.
• The buyer is paying cash and will receive the entire reduction immediately.

But for a financed buyer struggling with cash or the monthly payment, a $10,000 price reduction may provide less immediate help than expected.

Option 2: Use the $10,000 Toward Closing Costs

Instead of lowering the price, the seller may agree to pay up to $10,000 of the buyer’s allowable closing expenses.

Those expenses can include items such as lender charges, title expenses, appraisal fees, prepaid taxes and insurance, discount points and other eligible costs approved by the buyer’s lender.

If the buyer has at least $10,000 in eligible expenses, the credit could reduce the amount needed at closing by the full $10,000.

Compare that with the price reduction, which lowered the 5% down payment by only $500.

The buyer’s loan and monthly payment remain higher, but the buyer keeps substantially more cash on hand for moving, repairs, furnishings, emergencies or reserves.

This can be especially valuable for a buyer who has sufficient income to handle the payment but does not want to exhaust every available dollar at closing.

A closing-cost credit may be the strongest choice when:

• Available cash is the buyer’s primary obstacle.
• The buyer wants to preserve an emergency fund.
• The home will need repairs, appliances or improvements after closing.
• The buyer expects to refinance or sell before realizing the long-term benefit of a price reduction.
• Lower cash requirements would allow the buyer to purchase sooner without becoming financially stretched.

A seller credit cannot simply become cash in the buyer’s pocket or replace the required down payment. The buyer must have sufficient eligible expenses, and the contribution must comply with the loan program and lender’s requirements.

Option 3: Use the $10,000 for a Temporary Rate Buydown

The seller’s concession might also fund a temporary mortgage-rate buydown.

With a 2-1 buydown, the buyer’s payment is calculated during the first year as though the interest rate were two percentage points below the permanent note rate. During the second year, it is calculated at one percentage point below the note rate. Beginning in the third year, the buyer makes the full payment required by the mortgage.

Using our example:

• Permanent note rate: 6.625%
• First-year payment based on 4.625%: approximately $1,954
• Second-year payment based on 5.625%: approximately $2,187
• Full payment beginning in year three: approximately $2,433

The temporary payment reduction would be approximately:

• $479 per month during the first year
• $246 per month during the second year

Funding that 2-1 buydown would require approximately $8,702. The remaining portion of the seller’s $10,000 concession might be available for other eligible closing expenses, subject to the lender’s approval.

This option does not change the permanent interest rate or the actual terms of the mortgage. The seller’s money is placed into an account and used to subsidize a portion of the buyer’s scheduled payments during the buydown period.

If the buyer sells, refinances or pays off the mortgage before all the buydown funds have been used, the treatment of the remaining money depends on the written buydown agreement. Buyers should confirm those terms with the lender before closing.

The buyer must ordinarily qualify using the full payment at the permanent note rate—not the temporarily reduced payment. Fannie Mae permits temporary buydowns on eligible fixed-rate mortgages for principal residences and second homes, subject to its requirements and applicable contribution limits.

A temporary buydown may be attractive when:

• The buyer expects income to increase during the next two years.
• The buyer wants additional room in the budget immediately after moving.
• The first years of homeownership will include substantial furnishing, repair or childcare expenses.
• The buyer expects rates may eventually permit a beneficial refinance but can comfortably afford the permanent payment if that never happens.

A temporary buydown should never be used to make an otherwise unaffordable home appear affordable. The buyer must be prepared for the full payment when the subsidy ends.

What About a Permanent Rate Buydown?

Seller money may also be used to purchase discount points that permanently reduce the mortgage rate.

Unlike a temporary buydown, a permanent buydown lowers the rate for the life of the loan. That can potentially produce meaningful long-term savings.

But there is no fixed rule stating that one point will reduce the interest rate by a particular amount. Pricing changes among lenders, loan programs, borrowers and market conditions. One point equals 1% of the loan amount, but the rate reduction received in exchange for that point varies.

The Consumer Financial Protection Bureau recommends comparing the upfront cost with the monthly savings over several possible timeframes. The key question is how long the buyer must keep the mortgage before the accumulated monthly savings exceed the amount spent on points.

For example, if a permanent buydown costs $10,000 and saves $150 per month, the approximate break-even period would be 67 months—or about five years and seven months.

If the buyer sells or refinances before then, the permanent buydown may not recover its cost. If the buyer keeps the loan considerably longer, it may become the most valuable option.

Permanent buydown pricing must therefore be calculated using an actual lender quote when the buyer is ready to make the decision.

Which Option Is Best?

There is no single choice that is best for every buyer.

If the buyer’s biggest concern is cash at closing, the closing-cost credit may provide the greatest immediate benefit.

If the buyer’s biggest concern is the payment during the first two years, a temporary rate buydown may provide the most noticeable short-term relief.

If the buyer wants less debt and permanent savings, the price reduction may be the better choice.

If the buyer expects to keep the mortgage for many years, a permanent rate buydown may deserve consideration—but only after calculating the break-even period using current lender pricing.

The decision can be summarized this way:

The Seller May Care Which Option You Choose

From the seller’s perspective, these choices may appear financially similar. A $10,000 price reduction and a $10,000 closing-cost contribution can both reduce the seller’s proceeds by approximately $10,000.

But the seller may respond differently depending on the property and transaction.

A price reduction may reduce fears the contract price could exceed the appraised value. A seller may prefer to maintain the asking price while contributing toward the buyer’s expenses. Another seller may resist paying closing costs but accept a lower price because it feels cleaner.

The offer should be structured around both the buyer’s greatest benefit and the terms the seller is most likely to accept.

Start With the Buyer’s Actual Problem

Buyers often focus entirely on negotiating the lowest possible price.

But the best negotiated offer is not necessarily the one with the lowest contract price. It is the one that creates the strongest overall financial outcome for that particular buyer.

Before deciding what to request, we should identify the buyer’s primary objective:

• Preserve cash at closing
• Lower the monthly payment
• Reduce long-term debt
• Fund immediate repairs or improvements
• Maximize the likelihood the seller accepts the offer

The buyer’s expected ownership period, anticipated mortgage duration and ability to afford the permanent payment should also be considered.

Once those questions are answered, the same $10,000 can be directed where it will help the buyer most.

If you are deciding how much to offer on a specific property, read How Much Below Asking Price Should I Offer on a Home in Middle Tennessee Right Now?

If you are deciding whether to purchase now or wait for mortgage rates to change, read Should I Buy Now or Wait for Lower Mortgage Rates in Middle Tennessee?

Joe Hafner has more than 30 years of real estate experience and has participated in more than 1,000 transactions. As principal broker of Hafner Real Estate and a Real Estate Mortgage Loan Originator, he helps Middle Tennessee buyers evaluate both the real-estate and financing sides of a purchase.

To discuss a property-specific offer or mortgage strategy, contact Joe at Joe@HafnerRealEstate.com.

All payment figures are estimates for illustration only and include principal and interest. They exclude taxes, insurance, mortgage insurance, association fees and other expenses. Interest rates, discount-point pricing, closing costs, contribution limits and loan eligibility vary by borrower, property, lender and loan program.