The Economics of Selling a Home
A key factor in determining whether you should sell is whether you can afford to sell. So it's helpful to know:
- Common selling expenses
- The tax implications of selling
- The ways in which selling can impact your finances
Keep in mind that the costs and financial ramifications of selling can vary widely, based on such factors as the selling price of the home, the property tax rates in your area, and the distance of your move.
Common Selling Expenses
The seller bears the burden of most of the expenses required to facilitate the sale of a home. The profits you receive from selling your home (if any) will equal the selling price of the home, minus:
- The principal balance on your mortgage (if any)
- The various costs required to sell the home
- The taxes you must pay as a result of selling
The Main Selling Expenses
The most common fees that people pay in order to sell their homes include:
- Agent commissions: As the seller, you pay the commission for both your agent and the buyer's agent, which typically totals 5-7% of the home's selling price. For instance, if your home sells for $300,000, you might pay $18,000 in commissions.
- Property inspections: Many sellers pay a home inspector to inspect their property before putting it on the market. The average cost of an inspection is around $325 but varies according to geographic location and the size of the home. A pest inspector may cost you an additional $75-150.
- Repairs and improvements: Many property inspections yield home issues that the seller must resolve, such as corroded pipes, broken appliances, or faulty air-conditioning systems. In addition, most sellers make upgrades¬—a fresh paint job or new carpeting, for example¬—before putting property up for sale. Expect to budget at least a few thousand dollars for these repairs and improvements.
- Closing costs: The closing is a meeting that marks the end of the sale. At the closing, you receive money from the buyer (and his or her lender) and hand over the keys to your home. Closing costs are the fees involved in finalizing the documents required for the closing. The seller's closing costs are negotiated with the buyer. Depending on the market, local practices, and other factors, these costs can either be minimal or as much as 5% or more of the home's sale price. That's in addition to real estate agent commissions you pay.
- Prepayment penalties: Some mortgages include prepayment penalties, fees that lenders charge if you pay off a mortgage early (before the full term of the loan has expired). Since most sellers do pay off their existing mortgages early and in full when selling, you should check to confirm whether your mortgage includes prepayment penalties. If so, make sure you're prepared to pay these fees in addition to the other costs of selling your home. Though prepayment penalties vary, they generally cost 1-2% of the outstanding loan balance, or the next six months' worth of interest on the loan.
- Moving expenses: These costs include packing supplies and hiring a moving company. Even if you plan to move yourself, you'll still incur costs such as truck rental and fuel fees. It can cost a few hundred dollars or several thousand dollars to move, depending on the amount of stuff you have and the distance you'll be traveling.
The Tax Implications of Selling a Home
Taxes can take a substantial bite out of the profits you make from selling your home. There are three types of taxes you may have to pay:
- Transfer taxes: Taxes that your state or local municipality might charge for selling (or "transferring") your property. These taxes are usually equal to 1-2% of the sale price, though they vary, depending on your state's or local municipality's tax policies. Contact your local tax assessor's office to determine the transfer tax amounts for your area.
- Prorated property taxes: Property taxes are usually due annually or semiannually. Depending on when you submitted your most recent property tax payment, you'll either owe your buyer a prorated share of property tax payments, or your buyer will owe you a credit for the property tax you've prepaid. Since it's impossible to predict exactly when your sale will occur, plan to set aside 3-4 months' worth of property tax payments once you decide to sell your home.
- Capital gains taxes: These are taxes that you pay on the profit that you make from selling your home. Not all profits from the sale of a home are taxable. Exclusions can range from $250,000 for single filers to $500,000 for married couples filing jointly. Specific rules govern whether you qualify for an exclusion, so before you decide to sell, consult your accountant or tax advisor to confirm the capital gains and tax ramifications of selling. If you don't qualify for these exclusions, or if you have a profit on the sale of your home that exceeds the exclusion amounts, you'll most likely be required to pay tax equal to 15-35% of your profits, or 15-35% of the amount of your profits that exceeds the exclusion amounts.
Selling-Related Tax Deductions
You can usually subtract expenses incurred in the process of selling your home from any otherwise taxable gains you receive from selling. Such expenses include:
- The commission you pay to your agent
- Fees for any attorneys you use
- Some closing costs, such as title-, escrow-, and deed-related fees
- Expenses related to ads you placed
- Any loan fees you pay on behalf of the buyer
Can You Really Afford to Sell?
Now that you know the main costs and tax ramifications of selling your home, it's important to do some basic math to figure out whether you truly can afford to sell. It's essential to do these calculations before you decide to sell. The first step is to project a total cost of selling based on thesefour expenses:
- 1. Selling your current home: Expect to spend about 10% of your home's sale price on the costs required to sell it, including agents' commissions. Set up a consultation with a real estate agent in your area to determine an approximate sale price for your home. Most agents will conduct a rough assessment for free.
- 2. Paying off your mortgage principal: Most homeowners pay off their mortgage principal (remaining balance) in full when they sell their current home. If your current loan has no prepayment penalties, you won't have to pay any additional fees to pay off your principal. If your loan does have prepayment penalties, confirm with your lender the specific amount you'll be required to pay.
- 3. Moving: Contact movers or a rental-truck company in your area to get an estimate.
- 4. Paying taxes: Add up the total tax liabilities you expect to incur when you sell. These include transfer taxes, property taxes, and capital gains taxes.
How to Calculate Your Expected Profits from Selling
To get a rough estimate of the profits you might receive from selling (after taxes and expenses), subtract the sum of the four costs above from your projected sale price. For instance, if your costs total $150,000 (including paying off your existing mortgage) and your sell your home for $200,000, your profits will be $50,000.
- If you get a positive number: You most likely can afford to sell your home, as long as the amount of your profits will cover the costs required to buy your new home and pay the ongoing costs of owning that home.
- If you get a negative number: You most likely cannot afford to sell your home at this time. Consider waiting until your equity increases or until you have sufficient savings. If you already have significant savings, you might still be able to sell, unless you need those savings to cover monthly bills, medical bills, or other pressing expenses.
The Cost of Buying Your Next Home
The impact that selling your home has on your overall financial situation depends on the expenses you'll incur in your new home and neighborhood. Before you decide to sell, consider:
- Housing-related expenses: Moving to a more expensive home or neighborhood usually means higher housing-related expenses, such as a higher initial down payment, bigger monthly mortgage payments, higher property taxes and utility bills, and a more expensive homeowner's insurance policy.
- Non-housing-related expenses: Your cost of living includes expenses such as groceries, transportation, and entertainment. The city in which you live tends to impact your cost of living more than any other factor, so don't assume that your cost of living will go down just because you're moving into a cheaper home.
- Tax deductions: Moving into a less expensive home not only lowers your housing-related expenses but also tends to reduce the amount of your annual tax deductions. To get an idea how your taxes might change, consult your accountant or tax advisor.
If You Can't Afford to Sell, Should You Sell and Rent?
Homeowners who don't have enough money to finance both the sale of their current home and the purchase of a new home may decide to sell their home and rent a new home instead. Since renting doesn't involve the various costs of buying a home (securing a mortgage, for example), it's usually a more affordable short-term option. However, because renters don't build equity or receive the tax benefits that homeowners do, renting is often much more costly than owning a home.
If you already own a home that you can afford and don't really need to sell, you should probably not resort to renting. Consider moving into a rented home only if you cannot afford your current home and must establish a more affordable living situation right away.
Should You Offer Seller Financing?
Seller financing is an arrangement in which you agree to loan a potential buyer the money he or she needs to buy your home. The buyer then agrees to pay you interest on that loan as he or she pays it back, usually in monthly installments. Seller financing appeals to buyers and sellers for these reasons:
- Buyers: Seller financing allows buyers to avoid the entire process of dealing with an official lender. That often means lower closing costs for buyers, plus another perk: less stringent standards. Since sellers are eager to find a buyer, move, and begin collecting interest off of the buyer's loan, they're typically more willing to overlook a buyer's financial problems, such as an especially low credit score, than lenders are.
- Sellers: A seller can end up making hundreds or thousands of dollars per year in interest by financing the buyer's loan. Also, since seller financing generally appeals to buyers, offering it can attract more of them.
Since seller financing appeals to buyers who might not qualify for a loan from an official lender, it can be a risky prospect for sellers. Buyers with poor financial track records often continue to have problems paying their bills, and as a seller, you might end up becoming a frustrated creditor. Worse, if your buyer fails to pay you back, you may be forced to foreclose (take back) the home. Generally it's best to avoid seller financing, especially if you're a first-time seller.