Closing cost credit can be reduced by a closing agent depending on the amount the lender allows. Understand what counts as a closing cost.

Q:   It is a second home for us and was considered an investment property although the truth is we bought the condo for our son.

At the closing table we were informed that the 3 percent closing cost credit agreed to in the contract by the seller had to be reduced to 2 percent leaving us to come up with another $680 on the spot.

Is this a fact that with a traditional loan with 20 percent down the seller is not able to give a buyer a 3 percent closing cost credit for the purchase of a home?

A: Lenders do, in fact, have restrictions on the amount of money a seller can give to the buyer as a closing cost credit. Depending on the loan program you are in, those restrictions can reduce a closing cost credit that a seller may have offered you on the purchase and sale agreement.

Frequently, contracts for the purchase and sale of a home will provide that a seller will give the buyer a closing cost credit – that is money to pay for closing expenses – of a certain amount at the closing. But, the contract will also state that the closing agent may reduce the credit depending on the amount the lender is willing to allow.

A lender will generally allow a credit for up to 4, 5 and even 6 percent of the purchase price for a home but the credit must be applied towards legitimate closing costs. If you run out of closing costs, the lender will not allow further credits to be applied.

In your situation, if your 3 percent credit was equal to about $2,000, but you only had about $1,300 in closing costs, the lender would only allow you to apply $1,300 of the $2,000 towards those costs. You would still have other expenses on the day of the closing, but those other “expenses” might not be considered closing costs. And, you would lose the balance of the funds.

You can usually expect that title company fees, recording charges, transfer taxes and certain of the lender fees will be allowable closing expenses. However, real estate taxes and prepaid interest expenses are not considered allowable closing costs for purposes of a closing cost credit.

At issue here is whether the closing cost adjusts the purchase price in the eyes of the lender. That is to say, if the closing cost can be viewed as a reduction in the purchase price, then the closing cost credit can cause problems.

Here’s why: if your loan is 80 percent of the purchase price and the purchase price is adjusted down by any amount, your loan would have to go back into underwriting as a loan with a loan to value of more than 80 percent. You might also need to obtain mortgage insurance on that loan as well.

You raise a good question that is missed by many home buyers (particularly first-time home buyers) who ask for and expect to receive a closing cost credit from a seller. If you’re buying a property and plan to ask for a closing cost credit, you should make sure you know what expenses you will incur in the closing and which of those expenses can be used against a closing cost credit.

In some cases, points paid to a lender to reduce the interest rate on the loan will increase your fees at closing, but those points can usually be counted against a seller given credit.