Sellers use the concession to motivate unwilling or skeptical buyers to purchase and close on a real estate contract. As we’ll discuss more below, these inducements usually involve the seller’s paying closing costs or prepaying the initial homeowner’s insurance premium, property taxes or other prepaid expenses. Concessions affect how appraisers value property and the methods employed to get at an accurate, reliable opinion of value.
Why Does A Buyer Seek A Seller Concession?
In the typical real estate transaction, the buyer must bring enough money to closing to meet various closing costs and expenses. Many of these are associated with mortgages. These items include:
*Origination Fee: Usually between one-half percent and one percent of the loan, the original fee represents the lender’s charge for application processing.
*Appraisal Fee: Lenders require that the home appraise at a given value. Appraisals also affect whether a borrower must purchase private mortgage insurance (PMI). This product is required when the value of the home is less than 80 percent of the loan.
*Home Inspection Fee: These professionals comb the property for visible defects, such as cracks, leaks, water or other stains on the walls, floors or ceilings; and malfunctioning light switches or plumbing fixtures.
*Discount Points: To get a lower interest rate and lower monthly payment, borrowers obtain discount points (normally one percent). The upfront costs function as the purchase price for lower interest.
*Attorney Fee: Attorneys perform title searches and prepare the deed, settlement statement and other documents required at closing.
*Title Insurance Premium: Lenders require title insurance to cover the losses from and expenses to defend claims against the property. Potential title defects include other owners, judgments, mortgages, outstanding taxes and liens by contractors or providers of municipal services.
*Homeowner’s Insurance: Your lender will require you to have homeowner’s insurance so that reimbursement for losses due to fire or other casualties go to pay toward or satisfy the outstanding debt on the home. Part of the prepaid expenses at closing go to the first year’s homeowner’s premium.
For many buyers, these upfront costs prevent the purchase of a home. Buyers may also seek a concession if a home inspection or other methods reveal defects in the home. Problems that may call for remediation include damaged floors or discolored carpet or walls.
How Does A Concession Work?
With a concession, the seller agrees to bear closing costs either to make the purchase more affordable or to account for fixes desired by the buyer. The seller may pay these expenses or agree to take less money at closing. To do so, the final sales price will rise above the initial price by the amount of the concession. That figure becomes part of the loan. As such, a concession does not represent free money.
By way of illustration, suppose a home has an initial contract price of $300,000. If a seller agrees to $10,000 in concessions, the price of the home increases to $310,000, with the seller collecting $300,000 at closing. The extra $10,000 is rolled over into the loan.
Are There Limits To Concessions?
Depending on the type of loan and the down payment, sellers are limited in the concessions they can afford borrowers. For a loan backed by the Federal Housing Administration (FHA), the ceiling sits at six percent of the loan amount. The Veterans’ Administration limits the concessions to four percent of the loan amount.
With loans acquired by Fannie Mae and Freddie Mac, the down payments determine the concession limits:
*Three percent of loan with down payment less than 10 percent;
*Six percent of loan with down payment between 10 percent and 25 percent;
*Nine percent of a loan with more than 25 percent down payment.
These limits exist because concessions cause banks to loan more than the actual purchase price of the home. Below, you’ll see how a concession impacts the appraiser’s work in determining value.
Principles That Matter In Concessions
An appraisal represents an opinion by an appraiser of the market value of a subject home. Typical factors in the opinion consist of the home’s condition, space as measured by the square footage, materials used for the interior and exterior, how much the property slopes, and age. You may even find the location, mortgage interest rate and other market factors at play in an appraisal.
As another valuation tool, appraisers research the values of similar properties. To be reliable as comparables, the properties should have the same or similar square footage, condition, location or amenities as the subject property.
Perhaps more important than the physical characteristics is the proximity in time of the sales of the comparable properties. More recent transactions may more accurately reflect the current state of the real estate market. As a general rule, properties that sell more than twelve months prior to the subject property should not serve as comparables.
Does A Seller Concession Count In A Home’s Value?
As a general rule, appraisers do not reflect the concession in the home’s value. After all, the concession represents money that a seller does not receive. In our example above, the seller receives the same $300,000 had no concession been a part of the deal. Again, the $10,000 concession represents funds that the buyer does not have to bring to closing to complete the purchase. That $10,000 flows into the loan.
If a perceived defect in the property spurs the concession, an appraiser might have an argument that the increased price could serve as a market value. Specifically, the buyer and seller agree that the buyer would (theoretically) spend $10,000 for repairs and improvements. The upgrades would increase the property’s value up to $310,000.
Do Appraisers Use Concessions in Comparable Sales Analysis?
The presence of concessions on the subject property does not by itself justify adjusting the values on comparables. Appraisers must determine whether to account for comparables by examining the circumstances behind the sales of the comparable. The standard is whether the comparable properties would have sold at their respective properties without the concession.
Appraisers examine the prices and the contracts of the comparables and other property sales in the area. A consistent or frequent use of concessions in increasing the prices may support using them in the sales analysis. Specifically, such frequency suggests that the seller concession is a common practice in the market. Nevertheless, appraisers must report on their comparable sales analysis the concessions.
Our appraisers have Multiple Listing Service (MLS) data and other means to deliver reliable appraisals. If you’re interested in a free quote, call us at 1-801-822-2292!