SANTA CRUZ (May 1, 2010) - It has been said that the biggest obstacle to homeownership is coming up with the cash to cover the down payment and closing costs. FHA insured loans have the most friendly guidelines when it comes to this issue. In the first place, FHA allows a homebuyer to buy a home with a 3.5 percent down payment. That is the best that the mortgage industry offers. Secondly, FHA loans allow the down payment to be all gift and they allow the seller to pay up to 6 percent of the sales price towards the buyer’s closing costs.

One downside to an FHA insured loan is that it requires an impound, or escrow, account for the property taxes and homeowner’s insurance. There are pros and cons to an impound account but the main advantage is that since the monthly mortgage payment must contain a property tax payment and a hazard insurance payment, the homeowner will not have to worry about coming up with enough money to pay these sizable premiums when they come due.

The disadvantage is that the homebuyer must contribute between 3 – 8 months of property taxes plus 2 months of homeowner’s insurance into their impound account at the close of escrow. The number of months of property taxes is dependent on the month the escrow closes. In other words, due to the impound account the closing costs could increase by $4,000 or more for a home priced at $500,000. The homebuyer will need another $10,000 or so to cover the title, escrow and lender fees. The homebuyer will also be required to pay one year of homeowner’s insurance and the prepaid interest which can add another $2,000. The cash required, in addition to the down payment in this example, totals $16,000.

Fortunately, many sellers are often willing to help the buyer pay these costs in order to make their homes more attractive to cash-strapped buyers. The time to negotiate this help from the seller is when the offer is prepared and presented to the seller. Simple wording like “seller to pay $10,000 of buyer’s closing costs” is all that is needed in the purchase contract or in a subsequent addendum.

Confusion sometimes comes into play after the buyer and seller are in contract and the subsequent inspections reveal some work that the buyer would like to have done. While the seller may be willing to give some money to the buyer to cover repairs, the mortgage industry does not allow it. The seller is only allowed to help the buyer with the closing costs. Given the above example, if the seller agrees to ‘give’ the buyer $10,000 towards future repairs, it must be in the form of closing costs. We then have a conflict because now the seller has agreed to pay $20,000 but the closing costs only come to $16,000.

Since the seller cannot contribute towards the buyer’s down payment, to take full advantage of the seller’s willingness to contribute $20,000, either the sales price could be set $4,000 lower or the closing costs could be increased $4,000. Increasing the discount points paid would decrease the interest rate and monthly payments. Or, recently, I had a similar situation with a $2,000 overage and the solution turned out to be moving the first mortgage payment back one month. This increased the prepaid interest by nearly $2,000, which allowed the buyer to take advantage of the seller’s contribution to closing costs.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.