Everything You Need To Know About Mortgage Loan Lender Credits

If you are in the process of getting a mortgage loan to purchase a home or refinance your existing loan, you have likely come across the term “lender credit”. A lender credit is an amount of money provided by the lender to cover some or all of the closing costs associated with the mortgage loan.

While a lender credit can help reduce your upfront costs at closing, it is not free money. There are tradeoffs to consider when accepting a lender credit that will impact your mortgage loan over the long run. In this comprehensive guide, we will walk through everything you need to know about mortgage lender credits so you can decide if it makes sense for your home loan.

What is a Lender Credit?

A lender credit, also sometimes called a “no-closing-cost mortgage”, is an arrangement where the mortgage lender agrees to cover some or all of the closing costs on the buyer’s behalf. These closing costs are fees charged by the lender and third parties related to processing, underwriting, and finalizing the mortgage loan.

Typical closing costs covered by lender credits include

• Origination and underwriting fees
• Appraisal and credit report fees
• Title insurance fees
• Recording fees and taxes
• Loan application fees

In exchange for covering these upfront closing costs, the lender will charge a higher interest rate on the mortgage loan. This allows the lender to recoup the costs over the life of the loan through the additional interest you pay.

Essentially, lender credits allow you to finance closing costs into your mortgage loan balance rather than pay them in cash up front.

How Do Lender Credits Work?

When you apply for a mortgage loan, lenders will provide you with a Loan Estimate outlining all the expected closing costs. This helps you compare offers between lenders.

If you opt for a lender credit, the lender will provide a revised Loan Estimate showing:

• $0 in lender-paid closing costs
• A higher interest rate than previously quoted

For example, you may be quoted an interest rate of 3.5% with $5,000 in closing costs. With a lender credit, your new quote might be 3.75% interest and $0 in lender-paid closing costs.

The amount of the credit will depend on

• How much of the closing costs the lender agrees to cover
• Your credit score and financial profile
• Current mortgage rates and real estate market conditions

Typically, the more closing costs covered by the lender credit, the higher your interest rate will be.

Benefits of Lender Credits

There are some potential benefits of using lender credits to reduce your upfront closing costs:

1. Less cash needed at closing – Since the lender covers certain fees, you won’t need as much money upfront to close on the mortgage. This can be helpful if you have limited funds for a down payment and closing costs.

2. Build home equity faster – Putting less money toward closing costs means you can allocate more of your cash to the down payment. This helps you build equity in the home faster.

3. Pay off PMI faster – On conventional loans, a larger down payment helps you reach 20% equity sooner so you can eliminate private mortgage insurance (PMI) faster.

4. Finance closing costs – Rather than pay thousands in closing costs up front, you can finance them into your loan balance at the cost of a slightly higher monthly payment.

5. Short-term savings – If you only keep the mortgage for a few years, the higher interest costs are minimal compared to the thousands saved upfront.

What Closing Costs Can a Lender Credit Cover?

Lender credits can be applied toward the lender’s own fees as well as third-party fees charged during the mortgage process. Typical closing costs that lender credits cover include:

• Origination fee – This covers the lender’s administrative costs to process the loan application and underwrite the mortgage. Origination fees range from 0.5% to 1% of the total loan amount.

• Appraisal fee – The property appraisal is ordered by the lender to determine the home’s value. Appraisal fees often range from $400-$800.

• Credit report fee – The lender will pull your credit report to review your credit standing. This usually costs $50-$100.

• Title fees – Title insurance and title searches help insure the property’s title is clear of defects. Title fees depend on loan amount and location but often total $1,000-$2,500.

• Recording fees – The lender has to pay to legally record your mortgage documents with the county. This runs $50-$200 on average.

Lender credits cannot be used for prepaid items like property taxes, homeowners insurance premiums, interest payments, or escrow deposits. You’ll still need to pay these costs upfront at closing.

Should You Take a Lender Credit?

Lender credits can provide nice upfront savings, but are they always the best option? Here are some key factors to consider:

• Loan term – Lender credits make the most sense if you only keep the mortgage 5-7 years. The higher interest costs over 30 years often outweigh the upfront savings.

• Interest rate increase – Compare the rate increase to see if the savings justify the cost. A 0.25% increase may be negligible but 0.5% or more can add significant interest charges.

• Monthly payments – The higher rate also means higher monthly mortgage payments. Make sure the payment still fits your budget.

• Break-even analysis – Calculate when higher interest costs outweigh upfront savings. If it takes 10+ years to break even, a lender credit may not be best.

• Future plans – How long do you plan to stay in the home? If you may move or refinance within 5-7 years, lender credits make more sense than if you plan to stay long term.

Overall, lender credits can provide nice upfront savings for some homebuyers but aren’t the optimal choice for everyone. Think critically about your plans and run the numbers before deciding.

Lender Credits vs. Discount Points

Another way to lower your mortgage costs is through discount points. This involves paying additional money upfront to buy down your interest rate. It works opposite of a lender credit:

• Lender credit – Pay less upfront, higher rate over loan term
• Discount points – Pay more upfront, lower rate over loan term

Whether it’s better to buy points or take a lender credit depends on your break-even analysis. Discount points can save significantly over 30 years but may take over 10 years to recoup the upfront cost.

Here’s an example:

As you can see, the lender credit saves $5,000 upfront but has the highest monthly payment. The discount point has the lowest monthly payment but requires $7,500 upfront.

Run the numbers for your specific situation to see which pricing strategy saves you the most long-term.

How to Negotiate the Best Lender Credit Terms

You have some power to negotiate with lenders on the interest rate increase tied to a lender credit. Here are tips to get the best deal:

• Shop multiple lenders – Compare quotes from 3-5 lenders. Each structures lender credits differently so you can find the best rate.

• Improve your credit – Lenders offer better credit terms to borrowers with credit scores of 740+ and low debt-to-income ratios.

• Ask for discounts – See if lenders will discount origination fees or title fees to lower credit costs.

• Make a larger down payment – A 20% down payment gives you leverage to ask for a lower rate.

• Lock your rate early – Get quotes and lock your rate as soon as possible when rates are declining.

• Close within rate lock period – Make sure you close by the rate lock expiration to guarantee your quoted terms.

The mortgage lending market is competitive. With some savvy negotiating, you can often get lenders to reduce the rate hit from a lender credit.

Pros and Cons of Lender Credits

Let’s recap the key advantages and disadvantages of mortgage lender credits:

Pros

• Cover closing costs with no upfront payment
• Allocate more money to down payment
• Build home equity faster
• Eliminate PMI faster
• Require less cash to close
• Make sense if selling in 5-7 years

Cons

• Higher interest rate and monthly payments
• More interest paid over full loan term
• Higher long-term costs