What Is a Mortgage Lender Credit?
A lender credit is money that your mortgage company agrees to pay upfront to help offset your closing costs. The catch: You’ll typically pay a higher interest rate to get the credit. While a mortgage lender credit may be worth it if your budget is tight, you’ll want to consider the drawbacks, too.
What is a lender credit?
A lender credit is when the lender pays some or all of your mortgage closing costs. Lender credits are commonly associated with “no-closing-cost” mortgages. Despite the name, though, you’re still charged costs: However, the lender pays them by charging you a higher interest rate for the life of the loan.
Think of a lender credit as the opposite of paying mortgage points to get a lower rate. Rather than paying extra to reduce your rate, the lender fronts your closing costs in exchange for a bump in your rate.
How does a lender credit work?
Lender credits are tied to your interest rate. There’s no set formula for interest rates and lender credits, so you should compare rates from three to five lenders to see which offers the most credit for the lowest rate.
Lenders generally offer interest rates with three different types of pricing: par, above par and below par.
- Par pricing. This is a rate that doesn’t cost you a discount fee or give you a credit.
- Above-par pricing. This pays the lender a premium that’s usually passed on to you in the form of a lender credit at a higher interest rate.
- Below-par pricing. This costs the lender money that’s passed on to you and charged as a discount point at a lower interest rate.
The example below shows lender credits on a $250,000 loan with a 20% down payment and $5,000 worth of closing costs. We’ll start with a par rate of 3.25% and assume for every quarter of a percentage point higher in rate, the lender applies 1% of your loan amount toward your closing costs.
|Interest rate||Monthly principal and interest payment||Lender credit||Closing costs due after lender credit|
Now that you know how each rate option affects your monthly mortgage payment and closing costs, you can weigh the short-term perks against the long-term costs.
Short-term benefits compared with a 3.25% rate loan with no lender credits
- You save $2,500 at the closing table for a 3.5% interest rate.
- You’ll save $5,000 at the closing table for a 3.75% interest rate.
- Your payment increases only $34.59 per month for a 3.50% rate.
- Your payment goes up by just $69.71 per month for a 3.75% rate.
Long-term costs compared with a 3.25% rate loan and no lender credit
- You’ll pay $12,454.53 more in interest over the life of the 3.50% loan.
- You’ll pay $25,118.34 more in interest over the life of the 3.75% loan.
Your lender credit will show up as a negative number on page 2, section J of your loan estimate (LE) or closing disclosure (CD). For example, if you choose the 3.75% rate above, you’ll see a -$5,000 lender credit on your LE, reducing the closing costs you owe to zero.
When does it make sense to get a lender credit?
Getting a lender credit makes sense if your emergency savings are low, or you don’t plan to stay in your home for long. If your current mortgage is backed by the Federal Housing Administration (FHA), a lender credit may be the only way you can afford an FHA streamline refinance loan, because the program doesn’t allow you to roll closing costs into your loan amount.
To decide which interest rate option is best for you, calculate your breakeven by dividing the total closing costs by the monthly savings for each interest rate. The result equals how many months it will take to recoup your costs.
The calculations below show the breakeven for the rates and costs in the example above.
Divide $2,500 in costs by $34.59 in monthly savings = 72.28 months breakeven
Divide $5,000 in costs by $69.71 in monthly savings = 71.73 months breakeven
In other words, if you don’t plan to stay in your home for at least six years, getting a loan with a higher rate and a lender credit may make the most financial sense.
Lender credit limitations
A lender credit cannot be used toward:
- The down payment
- The cash reserves needed to prove you have the means to pay your mortgage if you lose your income
- The funds needed to pay off debt in order to qualify for a mortgage
Pros and cons of getting a lender credit toward closing costs
- You’ll keep more cash in your pocket.
- You’ll reduce the time it takes to recoup your costs.
- You may be able to deduct more mortgage interest on your taxes because your rate is higher.
- You could free up money to make a bigger down payment.
- You’re stuck with a higher interest rate and monthly payment for the life of the loan.
- You’ll pay more interest in the long run.
- You may have a harder time qualifying for a mortgage with a higher monthly payment.
- You may have to shop more to get your best lender credit options.
Alternatives to getting a lender credit
A lender credit is just one of many ways to slash your closing costs. Consider these other options:
Apply for closing cost assistance.Some housing finance agencies offer programs to help pay for closing costs if you meet the income and neighborhood requirements. Check with your local government or nonprofit housing agency to find out what’s available in your area.
Ask the seller to pay your closing costs.Most home loan programs allow the seller to pay closing costs on your behalf. For example, the seller can pay up to 6% of the price of your home toward your FHA closing costs.
Ask a relative for a gift to cover costs. If you have a family member or friend willing to help, many loan programs allow a donor gift to cover your closing costs.
Boost your savings. If you’re planning to buy or refinance a home in the near future, try to budget enough for your closing costs. You could open a high-interest savings account and set up automatic deposits to build up a closing cost fund.