Lender Credits: Definition And What To Know
When you buy a house or refinance, it’s important to consider several costs. While it might be easy to remember the down payment or equity you’ll need to meet your goals, not everyone factors in closing costs, which are typically 3% – 6% of the loan amount.
If you’re trying to save on costs, a lender credit may help. Let’s take a close look at what lender credits are, how they work, the pros and cons of lender credits, and other ways to save on closing costs.
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What Is A Lender Credit?
Lender credits are when a lender agrees to take on part or all a borrower’s closing costs in exchange for the borroweragreeing to a higher interest rate for the loan. The higher the credit, the greater the interest rate increase.
The rate you receive will vary depending on the size of your lender credit. This adjustment is made after accounting for items that influence your rate, such as your credit score and the size of your down payment.
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Is Accepting A Lender Credit For Closing Costs A Good Idea?
Lender credits carry the benefit of helping buyers with home affordability by reducing or eliminating closing costs. For the same reason, these credits can also provide an easier path to refinancing. However, lender credits can also have their downsides.
Pros Of Lender Credits
Lender credits have at least a couple of advantages. Let’s break them down:
- Lower upfront costs: They can vary with the type of loan you’re getting, but closing costs are generally 3% – 6% of your loan amount. Given this, lender credits could reduce or eliminate a barrier to buying a home or refinancing your current house.
- The potential to buy a house faster: Often, one of the biggest obstacles to buying a home is having to come up with a down payment. However, reducing or eliminating closing costs could allow you to put more toward a down payment and get a home sooner, as long as the higher payment still leaves you with a qualifying debt-to-income ratio (DTI).
Cons Of Lender Credits
Lender credits also have their downsides. For example:
- Paying more over the life of the loan: Because your interest rate will be higher than if you hadn’t taken lender credits, you’ll pay more in costs over the life of the loan. You’re trading lower costs upfront for higher costs later on.
- Higher mortgage payments: Since your interest rate is higher, you’re going to have higher mortgage payments than someone with the same loan term and a lower rate.
- The potential for higher costs when refinancing: When you refinance your existing mortgage, you’re paying off your full mortgage balance. Because the interest rate is higher than your original loan, you might need to take a slightly higher loan balance when refinancing to pay it off, and this could lead to higher closing costs.
Lender Credits Vs. Mortgage Points
Lender credits are the opposite of another mortgage mechanism known as discount points. Sometimes referred to as mortgage points, discount points are extra costs borrowers can pay upfront in the form of prepaid interest to lower their mortgage rate.
Almost any mortgage rate you see advertised has a certain point level tied to it. When you take a lender credit to lower your closing cost, you’re taking a rate tied to negative points. One point is equal to 1% of the loan amount. Foran example of the way mortgage lenders set pricing, here’s a table of hypothetical rates:
Rate | Points |
|---|---|
5.25% | 2 |
5.5% | 1 |
6% | 0 |
6.5% | -1 |
Lenders cover some or all your closing costs when you take a negative rate. When you pay for mortgage points, you end up saving money on interest over time. Be aware of when you’re going to break even on the deal so you can know if it makes sense for you.
Points Example
Let’s say you’re getting a $200,000 home loan and want to know when you’ll break even by paying for two points to lower your payment by $50 per month.
First, multiply the loan amount by 2%. Remember, 1 point equals 1% of the balance. This comes out to $4,000 ($200,000 × 0.02). Next, divide this number by your monthly savings, $50. You’ll break even in 80 months ($4,000 ÷ $50), or 6 years and 8 months.
It makes sense to buy the points if you have the money and expect to stay in the house for that time without refinancing. It’ll pay off in the long run. Otherwise, don’t worry about putting extra toward closing costs. Instead, put it toward something else, such as your down payment.
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Tips For Saving On Closing Costs
If you don’t want to take a lender credit but you’re still looking to save on closing costs, you could ask for seller concessions. Seller concessions involve a seller paying part of your closing costs. A seller might agree to this if they’re super-motivated to sell the house or you’re offering them a higher price in exchange.
It’s also possible to save if the appraised value comes in at or above the price you’re offering. In this scenario, you can add the amount you’re saving in closing costs into your loan amount without paying a higher rate.
The Bottom Line: Using Lender Credits Is A Way To Lower Closing Costs
Lender credits can be an effective way for those looking to buy a home or refinance to lower the closing costs associated with getting a mortgage. The strategy does have its advantages and disadvantages.
On one hand, you’re lowering your closing costs, which would enable you to put more toward a down payment. On the other hand, you’re opting for a higher rate and paying more over the life of the loan.
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