One of the most common questions homebuyers have when taking out a mortgage is what lender credits are and what they can be used for. Knowing this information can help you make informed decisions about your home purchase and get the best possible deal. Let’s look at lender credits and how they can help you with your home mortgage.
What Are Lender Credits?
Lender credits are discounts offered by the lender that apply to closing costs and reduce the amount of money you pay at closing when purchasing a home. These credits help offset the total closing costs, such as appraisal fees, title fees, pre-paid interest, or even points that reduce your interest rate. Essentially, it’s an incentive from the lender to get you to use their services for your home loan.
Lender Credit Limit
You may be wondering if it is possible to get a lender credit large enough so that you don’t have to bring in any funds to buy a home. Unfortunately, the simple answer is no. The total amount of credits combined in a transaction, including lender, real estate agent, and seller credits, cannot exceed the total closing costs, meaning they can’t help cover the down payment.
Except for 0% VA financing and some down-payment assistance programs, you will have to pay for your down payment out of pocket. The minimum down payment amount required for FHA financing is 3.5% and 3% for qualifying conventional financing.
When Should You Use Lender Credits?
Lender credits are beneficial if you don’t have enough cash to cover all of your closing costs or if there are no other options to lower them (such as waiving impounds or negotiating with the seller).
However, it’s important to remember that while they may help lower the amount due at closing, they will typically increase the interest rate you are getting. Bear in mind that not all lenders offer lender credits, so it’s essential to do your research before deciding which lender is right for you.
A Worked Example
Say you’re financing $400,000. A lender might offer a $4,000 credit toward your closing costs in exchange for raising your rate by roughly 0.25% (for example, from 6.50% to 6.75%). On a 30-year loan, that higher rate adds about $60 to your monthly payment. So you’d save $4,000 at the closing table now, in exchange for paying a bit more each month. If you plan to sell or refinance within a few years, the upfront savings often come out ahead; if you’ll keep the loan for the long haul, the lower rate without credits usually wins. Exact credit amounts and rate adjustments vary by loan type, market conditions, and your specific scenario.
What Are The Closing Costs And Expenses When Buying A Home?
Closing costs refer to any fees related to buying or refinancing a home that is not part of your monthly mortgage payment (such as principal and interest). These include but are not limited to discount points, appraisal fees, pre-paid interest, title search fees, transfer taxes, and survey fees.
Closing costs can vary significantly depending on the property location, the title company, the lender you use, or whether you wish to get an impounds account.
Other costs related to purchasing a home that are usually not a requirement by the lender, such as termite or roof inspections, can also affect the total closing costs. If these costs are paid for outside of closing, the lender credit will not be able to cover them.
What Are The Closing Costs That The Lender Charges?
There are different fees a lender or mortgage broker can charge you in exchange for their service. Some examples are discount points, origination fees, and processing fees.
- Discount points are upfront payments made in exchange for a lower interest rate over the life of the loan. These points are paid at closing and typically range from 0-3%. The amount paid will depend on the type of loan you’re getting and the current market conditions at the time of purchase or refinance. Generally speaking, paying discount points may be beneficial if you plan on staying in your home for several years since it could save you money over time due to lower monthly payments.
- Origination fees are paid directly to your lender or broker for their service.
- Processing fees (also known as underwriting fees) are paid to the lender for processing and underwriting your loan.
| Lender Credits | Discount Points | |
|---|---|---|
| Direction of trade | Lender pays you toward closing costs | You pay the lender upfront |
| Effect on interest rate | Raises your rate | Lowers your rate |
| Effect on cash at closing | Reduces cash needed | Increases cash needed |
| Effect on monthly payment | Slightly higher | Slightly lower |
| Best when | You're short on cash or plan to move/refi soon | You have cash and plan to stay long term |
| Paid | As a credit at closing | At closing, typically 0–3% of the loan |
For the full breakdown of how discount points and origination fees compare, see discount points vs origination fees.
Lender Credits And “No-Cost” Refinances
Homeowners often refinance to lower their monthly payments or to access equity in their homes for other purposes, such as debt consolidation or home improvements. Closing costs on a refinance loan can range anywhere from 2% to 6% of your loan amount.
When considering whether or not to refinance, it’s important to factor in all associated costs, such as title fees, appraisal fees, origination fees, etc., so that you have an accurate picture of how much a refinance will cost overall before making a decision.
JVM Lending can often offer homeowners a “no-cost” refinance when interest rates improve significantly. A “no-cost” refinance allows you to refinance your home without paying any out-of-pocket money for your closing costs. It is an excellent option for homeowners short on cash or want to save money in the short term.
Even though you won’t be paying in cash for your “no-cost” refinance, closing costs do not simply disappear. Instead, they are paid through a different method: during a “no-cost” refinance, lenders will either cover closing costs by 1) increasing your interest rate or by 2) financing the closing costs into the loan amount.
How do Lender Credits Help Homebuyers?
Lender credits help homebuyers by lowering the amount of money they need to purchase a home by reducing their total closing costs. This means you will have more funds for other expenses, such as moving costs or furniture purchases.
How Will Lender Credits Affect My Mortgage Payments?
If you take advantage of lender credits, your payments will not change since the amount borrowed remains unchanged regardless of how much credit you receive from the lender.
That said, it’s important to understand that by taking a higher interest rate in exchange for those credits, your overall cost for borrowing still goes up since you’ll pay more in interest over time due to that higher rate. However, if you plan on staying in your home long enough, those extra costs may very well be offset by the initial savings provided by those credits when you close your loan.
When and Why Lenders Offer Credits
Lenders offer credits because many buyers are better off keeping cash than chasing the lowest possible rate. Most borrowers keep a mortgage only four to seven years before they refinance or move, so the long-term cost of a slightly higher rate often never catches up to the money saved at closing. That short time horizon is the single biggest reason a credit can be the smarter choice, alongside a favorable rate environment where a small rate increase generates an outsized credit.
One important caution: avoid an early payoff. If you plan to refinance or pay off the loan within six months of closing, a lender credit can backfire. Lenders face a steep early-payoff penalty (EPO) on loans that are paid off almost immediately, and it can erase everything they earned on the loan. We once extended an $18,000 credit to a buyer who assured us he had no plans to refinance, then watched a big bank pursue him the week after closing. The early-payoff exposure ran well over $30,000. A credit works best when you intend to keep the loan at least past that initial window.
A credit that saved a deal: An agent brought us a $600,000 FHA buyer on a Friday night after her previous lender couldn’t offer a credit. The buyer barely had enough for the down payment, let alone closing costs. Because FHA financing carries larger rebates, we were able to offer a $13,000 lender credit, and the purchase closed. It’s a clear example of when a credit is the difference between a deal happening and falling apart.
Frequently Asked Questions
What are lender credits and how do they work?
Lender credits are discounts offered by a lender that reduce the amount you pay in closing costs when purchasing or refinancing a home. They can be applied toward expenses such as appraisal fees, title fees, prepaid interest, and origination fees. In exchange for these credits, the lender typically charges a slightly higher interest rate. The trade-off is less money needed at closing in exchange for a modestly higher rate over the life of the loan.
Can lender credits cover my down payment?
No. The total amount of all credits combined in a transaction, including lender, seller, and real estate agent credits, cannot exceed the total closing costs. Credits cannot be applied toward the down payment. Buyers are still required to cover their down payment out of pocket, with minimums of 3.5% for FHA loans and 3% for qualifying conventional loans.
When does it make sense to use lender credits?
Lender credits are most beneficial when you do not have enough cash to cover all of your closing costs and other options such as seller concessions or waiving impound accounts are not available. They are also useful in a no-cost refinance scenario, where the lender covers closing costs by either increasing the interest rate or rolling the costs into the loan amount. If you plan to stay in the home for a shorter period, the upfront savings from lender credits may outweigh the cost of the slightly higher rate over time.
Will taking lender credits change my monthly mortgage payment?
Not directly. Your monthly payment is based on the loan amount, which does not change because of lender credits. However, because lender credits typically come with a higher interest rate, you will pay more in interest over the life of the loan compared to a lower-rate option without credits. Whether this trade-off makes sense depends on how long you plan to stay in the home and how much cash you need to conserve at closing.
Lender Credits Summary
In conclusion, understanding what lender credits are and how they work can help potential home buyers make informed decisions about their mortgage loans and save money over time. Lender credits provide an attractive option for people looking to buy or refinance a home while keeping more money in their pockets over the short term. With proper research and guidance from experienced professionals like JVM Lending’s team members, homebuyers should have no problem finding the right fit for their unique circumstances and getting those all-important lender credits too!
