VA Seller Concession Rule

With the VA loan, no down payment does not mean no out-of-pocket loan costs for buyers. Instead, VA loan-related closing costs can add up to thousands of dollars, a lot of which must be paid in cash. Fortunately, using a process called seller concessions, the VA allows sellers to pay some of these costs on behalf of buyers. As such, we’ll use this article to explain the VA seller concession rule.

Specifically, we’ll discuss the following topics:

• VA Loan Overview
• Seller Concessions, Defined
• The VA Seller Concession Rule
• A Comprehensive Concession Example
• Final Thoughts

VA Loan Overview

The Servicemen’s Readjustment Act of 1944 created the original version of the VA loan, which was designed to offer returning troops a low-cost home buying option. The current version of the loan program offers eligible borrowers these outstanding terms:

• No down payment required
• No private mortgage insurance (PMI) required
• Low interest rates
• Streamlined refinancing option via the Interest Rate Reduction Refinance Loan (IRRRL)

Today, the Department of Veterans Affairs administers the loan program. However, the VA doesn’t actually lend money. Rather, it guarantees a portion of every loan issued by VA-approved lenders (e.g. banks, credit unions, mortgage companies, etc.). This system lowers risk for these lenders, because the VA will repay them a portion of any loan balance in default (i.e. a loan the borrower stopped paying).

But, with this VA guarantee comes VA-imposed restrictions. To issue VA loans, these lenders must abide by certain criteria required by the Department of Veterans Affairs. Of relevance to this article, the VA sets a maximum amount of allowable seller concessions, which we’ll discuss in detail in the remaining sections.

Seller Concessions, Defined

When you purchase a home, you must pay certain costs during the loan closing process. These costs include the items not including the down payment itself (e.g. mortgage points, title fees, VA funding fees, property taxes, etc.). While closing costs vary by loan type and unique situation, they typically range from 2% to 5% of a loan balance. For a $250,000 loan, this means buyers can face $5,000 to $12,500 in closing costs.

But, buyers can also ask for sellers to cover a portion of these closing costs. When sellers pay a portion of these costs, they provide seller concessions to the buyer. For buyers tight on cash, these concessions can make a huge difference in VA loan affordability.

Seller concessions typically come in one of two forms: 1) a percentage of the total closing costs; or 2) a specific closing-related cost (or costs).

Why Would Sellers Offer Concessions?

VA borrowers must understand, home sellers don’t need to provide concessions. Rather, seller concessions remain completely negotiable. As a buyer, you can ask for the world, but sellers can also refuse to provide any concessions. This begs the question, why would sellers want to provide buyers money during the closing process?

Generally speaking, home sellers offer concessions for one of two reasons, both of which relate to selling a home quickly. First, a seller’s personal situation may require selling a home as quickly as possible. For example, a seller may need the proceeds from one sale to purchase another home. Offering seller concessions can encourage a buyer to close as quickly as possible.

Second, sellers may face a buyer’s real estate market. In this environment, housing supply exceeds demand from buyers. As a result, homes tend to sit on the market for extended periods of time. During this time, sellers still face holding costs (e.g. mortgage payments, insurance, utilities, property taxes, etc.). To expedite sales, these people may offer seller concessions to encourage buyers to purchase their homes – not other ones on the market.

The VA Seller Concession Rule

The VA allows seller concessions. But, these concessions cannot exceed 4% of the appraised value of the property, that is, the VA loan amount with zero down payment. For instance, concessions on a $250,000 home cannot exceed $10,000 ($250,000 purchase amount x 4% limit).

What Does the VA Consider Seller Concessions?

The VA doesn’t consider all seller contributions towards this 4% limit. Rather, the VA only categorizes certain contributions made by the seller as concessions. Other contributions – despite being paid by the seller – are exempt from this 4% ceiling. Consequently, VA home buyers may receive more than 4% in total seller contributions.

Broadly speaking, the VA does not consider standard loan closing costs as seller concessions. However, seller payments made in excess of these ordinary closing costs qualify as seller concessions and must not exceed the 4% threshold. As such, buyers need to understand what does and doesn’t qualify as a seller concession. While not comprehensive, the below list includes common seller concessions on VA loans:

• Payment of the VA funding fee
• Property tax and insurance prepayments
• Gifts such as appliances (e.g. TVs, microwaves, etc.)
• Payment of extra mortgage points for permanent interest rate buydowns
• Payoff of credit balances or judgments on behalf of the buyer

In other words, sellers can contribute all ordinary loan closing costs on behalf of buyers, regardless of the 4% threshold. But, seller concessions related to the above list cannot exceed 4% of the purchase price.

For example, say the market dictates an interest rate of 5% with two discount points. If the seller paid those two discount points, it would not be considered a seller concession, as they’re ordinary loan closing costs. But, if the seller paid an additional two discount points to lower the buyer’s interest rate, those excess points would qualify as a seller concession and go towards the 4% ceiling.

Published VA material attempts to make this distinction as clear as possible: Do not include normal discount points and payment of the buyer’s closing costs in total concessions for determining whether concessions exceed the 4% limit.

Why the 4% VA Limit?

If a seller wants to provide concessions, why should the VA care? Unfortunately, sellers in some markets use these concessions as a competitive tool. And, in extreme cases, large concessions could entice VA loan borrowers to request home mortgages larger than they can actually afford. In other words, large concessions may disguise a veteran’s inability to qualify for a loan, which is why the Department of Veterans Affairs insists on a 4% ceiling.

A Comprehensive Concession Example

To put the VA seller concession rule into context, we’ll provide a comprehensive example. Assume a VA borrower applies for a $300,000 loan to purchase a home of the same amount. According to the 4% rule, the largest concession the seller can offer is $12,000 ($300,000 x 4%). But, the seller can also offer to pay all ordinary closing costs, regardless of this $12,000 ceiling.

To entice the buyer, the seller offers to A) pay all closing costs (not a seller concession), B) pay the VA loan funding fee (a seller concession), and C) pay off the buyer’s $8,000 credit card balance (a seller concession).

Assume that the ordinary loan closing costs total $9,000. The seller can cover all of these, as they do not count as concessions. Next, the funding fee totals $6,450 ($300,000 loan x 2.15% fee for first-time VA loan use). With the credit card payoff of $8,000, the seller has offered $14,450 in seller concessions ($6,450 VA funding fee + $8,000 credit payoff):

• $14,450 in offered seller concessions

Minus

• $12,000 in allowable seller concessions

Equals

• $2,450 in un-allowed seller concessions

In this situation, to comply with the VA’s terms, the seller would have to reduce offered concessions (either on the funding fee or credit card payoff) by $2,450. Total seller contributions would then equal $21,000: $9,000 in closing costs (no limit) and $12,000 in seller concessions (capped at 4% of property value).

Final Thoughts

Seller concessions can save VA loan borrowers a significant amount of out-of-pocket costs during the closing process. But, before accepting large concessions, buyers need to confirm that they comply with the VA seller concession rule. Understanding how these limits work before buying a home can save you a ton of time – and heartache – during the VA loan closing process.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.