No one likes to pay escrow and title closing costs. Buyers commonly ask: Isn’t the seller supposed to pay those? On the other hand, sellers also say: What are all these crazy costs – isn’t the buyer supposed to pay?
As a broker, what fascinates me about this is that buyers ARE sellers, and sellers ARE buyers, or will be, in a few years, or on a different property. They’re the same people! Of course they will forget that they thought that it was customary for the other guy to pay when it’s time for them to be on the other side of the transaction . . .
So who should pay for closing costs? My answer is: Although it’s entirely negotiable who pays closing costs it is generally unwise to negotiate! Regardless of the side you’re on, it’s actually in your enlightened best interest to agree to split costs with the other party. I’ll explain why.
But first things first – what are “closing costs” anyway? Let’s concentrate on the big ones and set aside the miscellaneous costs for now. In California, the big closing costs are the title policy, escrow, and the natural hazard report. Three other cost items are also large but they are not commonly referred to as “closing costs”. Those are back taxes, other liens, and the real estate commission. So in an effort to discuss all of the big numbers, I will touch on those later too.
The negotiation on “who pays what” starts when the buyer submits an offer. In California, the buyer makes his or her proposal using the checkboxes in paragraph 9 of the Vacant Land Purchase Agreement. There are two customary patterns for sharing closing costs.
First Common Pattern for Sharing Closing Costs
For vacant land parcels in California, the cost-sharing pattern that I prefer is to split all closing costs 50-50 between buyer and seller like this:
Second Common Pattern for Sharing Closing Costs
Also common is a cost-sharing pattern where the seller alone is asked to pay for title insurance, the natural hazard report and miscellaneous costs, while the escrow fee is split is 50-50. The logic behind this pattern is that the seller should demonstrate to the buyer that he is delivering clear title so he pays for a title report and title insurance to do that. Also the seller is required by law to disclose any natural hazards so the seller alone pays for a natural hazard report to comply with the law. This second pattern is common for homes in California so it often used for vacant land too:
Back Taxes, Liens and the Commission
Now let’s consider those other big-ticket items: back taxes, liens and the real estate commission. These are not referred to as “closing costs”. Buyers will be happy to learn that when using the standard California Vacant Land Purchase Agreement, those items will be paid for by the seller alone. In the agreement, paragraph 18B says “Title is taken in its present condition except for…monetary liens of record (which Seller is obligated to pay off)….” In paragraph 23 the agreement says: “The following items shall be PAID CURRENT … real property taxes and assessments….” Further, the seller signed a separate listing agreement with the listing agent promising that the seller alone would pay the entire commission.
So, if the standard purchase agreement is used, the escrow officer will automatically deduct liens and back taxes from the seller’s proceeds so as to deliver the parcel to the buyer “free and clear”. Escrow will also automatically deduct the commission from the seller’s side. Because these items are not commonly referred to “closing costs” there are no checkboxes for them in paragraph 4 of the purchase agreement. Unless there is some agreement to the contrary, in California the seller will pay all back taxes, liens and the commission and the buyer will not pay for them.
When Sellers are Asked to Pay for Everything and the Kitchen Sink (and There is No Kitchen)
Occasionally one of my sellers will receive an offer from a buyer represented by another agent where the buyer’s agent has checked off every single box in paragraph 4 and asked the seller to pay for all of it! They write in that they want the seller to pay for the well to be tested and sometimes they even indicate that when there is no well! They want a perc test, a survey performed, and the corners marked, and this, and that, etc. This kind of offer, where they throw it all in and see what sticks, is usually prepared by an agent who specializes in selling houses and condos, not vacant land.
When receiving an offer like this it’s best to just take a big breath and pull out the counteroffer form. While all items are negotiable, in my experience it is not customary for sellers to arrange or pay for “extra” items such as having the property surveyed (marking corners), testing the well, testing the septic system or performing a percolation (perc) test, etc. I generally advise my sellers to decline to pay for these items. However, some sellers do occasionally pay if they are highly motivated to sell and have the time to deal with surveyors or inspectors.
When sellers decline to pay it is still a customary to allow buyers to perform any surveys or inspections they care to perform at the buyer’s expense as part of their due diligence. So if you are a seller and you receive an offer like this asking you to pay for everything and the kitchen sink just prepare a polite counteroffer with the assistance of your broker stating what you will and won’t do and what you will and won’t pay for.
Not Sharing the Burden is Seen as Unfair
As a purely psychological matter, buyers really dislike being asked to pay what they perceive to be the “sellers” costs. Sellers also hate being asked to pay what they think are “buyers” costs. If asked to carry the load of the other person, each party will think the other is being an unfair meanie or a trickster trying to slip costs into the fine print of a deal.
Interestingly, the parties are likely to be far more accepting of negotiation on price. Buyers understand and accept that sellers want the highest price possible. In fact, buyers may even be a little sheepish and worried about submitting a low price offer and anxiously awaiting a counteroffer on price. Further, sellers understand the reality that buyers want the lowest price possible. The other party is unlikely to be perceived as “unfair” or “mean” by simply counter offering on price.
Thus, it is in the best interest of both to just accept the transaction costs of buying and selling real estate and negotiate on purchase price only.
Advice to Buyers
You should propose to split all closing costs with the seller 50-50 consistent with pattern 1. Why? Well, keep your end goal in mind: As a buyer, you want the seller to accept your offer as written with no counteroffer, right? Further, you want the seller to accept it quickly before another buyer submits a higher offer, yes? If you ask the seller alone to pay for some items consistent with pattern 2, a seller who does not buy or sell land every day and has not read this blog may wonder if this is customary. The seller may be annoyed. He may start calling Aunt Bessie in South Dakota who used to be a Realtor back in 1940 and ask her whether she thinks this is fair. He may call Cousin Bernie in Long Island who just sold his house to see what closing costs he paid. He may communicate back and forth with his agent on how to respond to your offer. He may request an estimate from escrow to see how big of a hit all these costs will be. All this flagellation takes time. The risk of time passing is that another buyer may appear on the scene in the interim. The annoyed seller may finally give you a counteroffer on who pays what closing costs. The seller might reason that as long as he is countering on closing costs he might as well ask for a higher price too as that requires no additional effort to slip into the same counteroffer. If you, as buyer, are not offering full price, the seller may factor in your unequal cost sharing proposal and “take it out on you” in his counteroffer on price.
So what you want to do, as buyer, is fly under the radar with your original proposal on how to share closing costs and be perceived as fair and reasonable. You want the listing agent to take your first offer to the seller and describe it as “clean”. The best way to accomplish that is to propose to share all costs 50-50.
Here is an example to illustrate the issues: California buyer Sally calls her agent wanting to submit an offer of $13,000 on another agent’s parcel of land priced at $13,000. The agent reminds Buyer Sally that her half of all closing costs combined will be approximately $850. Buyer Sally replies that she only has $13,000 and does not have $13,850. Buyer Sally wonders if she should ask the seller to pay all closing costs including her portion. The agent wisely recommends that Sally not do that and suggests that she submit an offer at $12,000 and offer to pay 50% of all closing costs. Sally does that. The seller counters at $12,500, Buyer Sally counters at $12,150 and the seller accepts. Sally pays a price of $12,150 plus $850 in closing costs for a total of $13,000. Both buyer and seller are happy.
Imagine if Buyer Sally had submitted an offer at $13,000 and asked the seller to pay 100% of closing costs? The seller would have been pleased with the full price offer but might have countered asking Sally to pay her own darn closing costs. Then Sally would have had to back-peddle on her offered price in order to afford her portion of the closing costs. The seller would have been annoyed at Buyer Sally trying to lower her offered price after offering full price and the deal might have fallen through. This demonstrates why buyers should just offer to split the closing costs upfront so that they can negotiate on one thing, price, not two things, price and closing costs.
Advice to Sellers
You should accept and agree to either of the two patterns described above for cost sharing because both are common and customary. If the offer is less than full price, do not negotiate closing costs – negotiate on price only. There is no point in negotiating on two things (price and closing costs) when you can simply negotiate on one thing (price). It all comes out the same in the end anyway. Don’t nitpick over details.
Here is an example: Seller John has his parcel listed for $20,000. Buyer Mary offers $15,000 and proposes that seller John pays the bulk of the closing costs consistent with pattern two above. Seller John is tempted to reply “Well, I’ll accept Buyer Mary’s (low) price if Mary will pay 100% of all closing costs.” However, John’s smart agent knows that Buyer Mary may balk at being asked to pay what Buyer Mary perceives to be Seller John’s portion of the costs, just as a matter of principle. If John were to pay the bulk of the closing costs as the buyer requested, his costs would be $975. The listing agent wisely advises Seller John to give Buyer Mary a counteroffer at a price of $15,975 and agree to share closing costs just as Mary proposed. Buyer Mary feels the price adjustment is quite reasonable in light of her low offer and accepts the counteroffer. Both buyer and seller are happy.
Advice to Agents
Perhaps, as a good fiduciary, you’re thinking that when you represent sellers you want the buyer to pay and when you represent buyers you want sellers to pay. Remember though, for the reasons mentioned in this blog, you don’t want to win the battle on closing costs only to lose the war on price. A good fiduciary should tell both their buyers and their sellers that they should carry their own weight and explain why doing so is actually in their enlightened best interest.
The bottom line is this: Don’t sweat the details on closing costs. Negotiate only on price.