Lender Credits: How They Work And If They’re Worth It

Buying a house entails more than just covering a down payment and inspection costs. You’ll also encounter fees like closing costs. Closing costs for a home can account for 3% – 6% of your total loan amount, and are due at the time of closing. Using a mortgage lender credit, however, could spare you some of your upfront costs.

Let’s discover how lender credits can help make home buying costs more affordable. After that, we’ll consider some drawbacks that come with lender credits.

What Is A Lender Credit?

A lender credit can reduce or cover your upfront closing costs when buying a home or refinancing. Lender credits are how your mortgage lender offers to pay for some or all of your closing costs – usually in exchange for a higher interest rate. This doesn’t include your down payment, which you’ll still be responsible for paying.

How high of an interest rate you pay will depend on a few factors related to your mortgage loan, including:

• Your mortgage lender
• The type of loan you agree on
• The state of the housing market
• How many lender credits you take

Generally, the more lender credits you accept, the more in closing costs your lender will cover – and the more your lender will raise your mortgage rates.

Lender Credits Vs. Mortgage Discount Points

Mortgage discount points are another option for borrowers looking to save on home-buying costs, except they are purchased by the borrower, not the lender. Borrowers purchase discount points at closing in exchange for locking in a lower interest rate. Borrowers will pay higher upfront costs but may save in the long run with lower mortgage rates.

Discount points typically sell in increments equal to 1% of your loan amount. Buying points makes sense if you intend on living in the residence long enough to recoup all your costs (i.e., the break-even point) before selling or refinancing. Otherwise, that extra money can be better allocated to a down payment or furnishing your new home.

What Lender Credits Can Cost You

Taking lender credits can significantly lower closing costs, but the increase in your interest rate – and therefore your monthly payment – can cost you more down the road than you save on the front end.

To demonstrate what lender credits can cost you in the long run, we’ll consider an example.

Let’s say you’re buying a house for a $300,000 loan amount with a 30-year term and 6% fixed interest rate. Your closing costs come out to $8,000, and you’re looking at a monthly payment of $1,799. Assuming you make your regular monthly payments and pay nothing more or less, you’d pay $347,515 in total interest.

Let’s say, though, that you want to make a 20% down payment and avoid private mortgage insurance (PMI) but can’t afford both the higher down payment and the $8,000 in closing costs. To cover those costs, you take some lender credits. In return, your interest rate is now 6.5%, bringing your monthly payment up to $1,896. Your total interest paid over the loan’s duration will now be $382,633.

By accepting lender credits and a higher interest rate, your monthly payment is nearly $100 higher than if you’d paid for the closing costs yourself. Over the life of the loan, you’d pay around $35,000 more in interest, as opposed to the $8,000 you would’ve paid in closing costs had you not gone for the lender credits. This is all after just a 0.5% increase in your interest rate.

To keep your interest lower, you could opt for enough lender credits to partially cover your closing costs, rather than covering all of them. Even a small increase in your interest rate, though, can ultimately cost you thousands of dollars in interest. 

Is Using Lender Credits For Your Mortgage Worth It?

Lender credits make sense if you’re trying to put more money toward a down payment or other expenses. The same may be true if you’re planning to move or refinance fairly early in the mortgage term, because the higher interest rate wouldn’t cost you nearly as much as it would if you kept the same interest rate and made payments over the full loan term.

Before you decide, though, consider the various benefits and drawbacks of using lender credits on your closing costs.

Pros

• You can pay less in upfront closing costs. As mentioned earlier, closing costs can account for 3% – 6% of your loan amount. Depending on how many credits you take, your lender can pay for a portion or all of your closing costs and save you thousands of dollars up front.
• You could buy a home sooner. The right time to buy a house is when you’re financially ready. If the closing costs are what’s in the way of your homeownership and you can handle a higher interest rate, taking lender credits to cover those costs can get you into your home faster.
• You could make a bigger down payment. A bigger down payment can mean a lower interest rate. If you have additional money to put toward a down payment after accepting lender credits, a higher interest rate may not hurt you as much as it otherwise would. Making a down payment of at least 20% can also let you avoid purchasing PMI.
• You could save money if you sell or refinance. If you plan to move or refinance the loan after a few years, the amount you pay in interest may still be less than what you would’ve spent in closing costs.

Cons

• You’ll pay more over the course of the loan. If you plan to live in your new home for a long time, or for the full term, you could pay thousands more in interest than you’d pay when not using lender credits.
• Your monthly mortgage payment will go up. With a higher interest rate, your monthly payment will be more than originally expected. This could mean not having as much to put toward other homeownership costs.
• You may see higher refinancing closing costs. Lender credits raise your loan’s value, and in doing so can raise the closing costs for a future refinance.

Other Ways To Reduce Closing Costs

Despite the costs and risks, lender credits can help home buyers overcome the hurdle of closing costs. Lender credits aren’t the only way to do this, though. Alternative options for easing your closing costs include:

• Seller concessions: If a seller is extra eager to finalize the sale, they may concede to cover some of the closing costs through what’s known as seller concessions. This will have no effect on your mortgage rate.
• Gift money: Many mortgage lenders allow borrowers to put gift money from friends or relatives toward their closing costs. The borrower should have a gift letter on hand if they plan to pay this way.
• Closing-cost assistance: Depending on your eligibility, you may be able to benefit from a first-time home buyer program that includes closing-cost assistance. Look up programs available in your area and see if you qualify for this type of help.

The Bottom Line

Taking lender credits can make sense if you’re not planning on staying in a home for the full term. If you are, the additional interest you’ll ultimately pay with lender credits can add up to thousands of extra dollars you’ll spend on your home. Your upfront closing costs will be reduced, but you’ll have a higher interest rate and monthly payment. This is worth it for some homeowners, but not all.

Consider your financial situation and intentions for your home before deciding to take lender credits.

Ready to become a homeowner? Start the mortgage process today with Rocket Mortgage^®.