February 25, 2021

Lender credits: How a mortgage lender can pay your closing costs

Lender credits: How a mortgage lender can pay your closing costs
Lender credits: How a mortgage lender can pay your closing costs

What are lender credits?

Lender credits are an arrangement where the lender agrees to cover part or all of a borrower’s closing costs. In exchange, the borrower pays a higher interest rate.

Lender credits
can be a smart way to avoid the upfront cost of buying a house or refinancing.

Getting
closing costs to $0 means you can put more of your savings toward a down
payment — or, in the case of a refinance, lock in a lower interest rate without
having to pay upfront fees.

But lender credits aren’t always the right
choice. For some borrowers, it makes sense to pay more upfront and
get a lower interest
rate. 

Here’s how to negotiate the best mortgage deal for you.

Check your no-closing-cost mortgage options (Feb 25th, 2021)


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How lender credits work

Lender credits are a type of ‘no-closing-cost mortgage’ where the mortgage lender covers all or part of the borrower’s closing costs.

Of course, lenders don’t pay borrowers’ closing costs out of generosity. In exchange for absorbing closing costs, the lender charges a higher interest rate. The ‘extra’ interest paid by the homeowner over time eventually repays any fees covered by the lender. 

Lender credits can be structured a few different ways, depending on what the lender agrees to cover and how much the borrower is willing to increase their mortgage rate.

For example:

  • The lender might cover all the borrower’s closing costs
  • The lender might cover its own fees and third-party services (like the
    appraisal) but not prepaid items (like property taxes and homeowners insurance)
  • The lender might cover only its own
    fees and none of the third-party services or prepaid items

The more of your closing costs a lender pays via lender credits, the higher your interest rate will be, and vice-versa.

Mortgage
pricing is flexible, and you can take advantage of tools like lender credits to
negotiate a rate and fee structure that works well for you.

Check your no-closing-cost mortgage options (Feb 25th, 2021)

How to compare mortgages
with lender credits

If you’re
considering a home loan with lender credits, it’s important to weigh the
short-term savings versus the long-term cost.

You might
eliminate your upfront cost with lender credits. But accepting a higher
interest rate means you’ll pay more interest in the long run. You’ll also have
a higher monthly payment.

If you keep
your loan its full term — typically 30 years — the amount of ‘extra’ interest
you pay could far exceed the amount you would have spent on upfront closing
costs.

However, most
home buyers don’t keep their mortgages for the full term. They sell or
refinance within a decade or so. And if you’ll only keep your loan a few years,
having a slightly higher interest rate might not matter as much.

So you need to
consider how long you plan to keep the mortgage before selling or refinancing
to decide if lender credits are worth it.

You should
also compare no-closing-cost loans from a few different mortgage lenders.

Each lender
structures lender credits differently — so you might find one that covers the
same amount of closing costs, but charges a lower interest rate than
another. 

And be sure to compare offers on equal footing.

If you look at
one lender quoting a zero-cost mortgage, and another that’s only covering origination
fees, for example, you’re going to see very different rates. So make sure all
the lenders you compare are covering the same amount and types of closing
costs.

You can find you total closing costs and how many lender credits are included on the standard Loan Estimate you’ll receive after applying with any lender. These documents make it easy to compare home loan offers side-by-side to find the better deal.

Are lender credits worth
it? An example

Typically, the
less time you keep your mortgage, the more you’ll benefit from lender credits.

Here’s an
example:

  No Lender Credits With Lender Credits
Loan Amount $250,000 $250,000
Interest Rate* 3.0% 3.75%
Upfront Closing Costs $9,000 $0
Interest Paid In 5 Years $35,500 $44,500
Interest Paid In 30 Years $129,500 $166,800

*Interest
rates are for sample purposes only. Your own interest rate with or without
lender credits will vary.

This home
buyer can take a 3% interest rate on a 30-year fixed-rate mortgage, with $9,000
in closing costs (3.6% of the loan amount). Or, they can accept a 3.75%
interest rate with $0 in upfront closing costs.

If the
homeowner keeps the mortgage 5 years or less, lender credits are likely worth
it.

At the end of
year 5, they will have paid $9,000 in ‘extra’ interest due to their higher
rate. But they saved $9,000 upfront. So if they sell or refinance any time before
the end of year 5, the savings from lender credits outweigh the added cost.

This point —
where the upfront savings level out with the long-term cost — is known as the
‘break-even point.’

If this
homeowner stays beyond the break-even point, they end up paying their
lender more in added interest than they saved upfront. So it’s easy to see how
lender credits don’t make as much sense if you plan to keep your loan a long
time.

However, there
are some scenarios where lender credits are worth it even for long-term
borrowers.

Lender credits in a rising interest rate environment

Even if you’ll
spend more in the long run, there are still scenarios where lender credits can
make sense. That’s especially true in a rising rate environment.

For example:

  1. A first-time home buyer wants to buy at today’s low interest rates, but
    only has enough saved for a down payment — not closing costs. This person could
    take a small rate increase, and may still lock in a lower rate than the one
    they’d get if they had to save another year or two and rates rose during that
    time  
  2. A homeowner bought their home a couple years
    ago and has an interest rate 2% higher than today’s rates. They want to
    refinance at today’s low rates but can’t afford closing costs. They could
    likely take a rate above the current market, get their closing costs paid by
    the lender, and still save money every month compared to their old loan

In these
cases, the higher interest rate is relative. Some homeowners can take a rate
increase on their lowest offer and still ‘save’ money overall.

Often, lender
credits are a matter of timing. They allow homeowners and home buyers to lock
during a low-rate environment, even if they don’t have the cash to cover
upfront fees out of pocket.

And remember,
lender credits aren’t all-or-nothing.

You don’t need
to take a big rate increase and get closing costs to $0. You can have the
lender cover part of your closing costs and take only a slight rate increase.

Make sure you
talk to lenders about all your options. And if one lender doesn’t offer the
right combination of rate and fees for you, shop around for another company
that will.

Compare no-closing-cost loans (Feb 25th, 2021)

Lender credits vs. discount points

Lender credits
work the opposite way, too. Instead of paying less upfront and taking a higher
rate, you can pay more upfront and get a lower interest rate.

This strategy
is known as ‘points,’ ‘mortgage points,’ or ‘discount points.’

Whereas lender
credits save you money upfront but increase your long-term cost, discount points cost you more
at closing but can save you a huge amount of money over the life of the loan.
Having a lower interest rate also reduces your mortgage payments.

Take a look at
an example:

  With 1 Discount Point No Points Or Credits  With Lender Credits
Loan Amount $250,000 $250,000 $250,000
Interest Rate* 2.75% 3.0% 3.75%
Upfront Closing Costs $11,500 $9,000 $0
Interest Paid In 5 Years $32,500 $35,500 $44,500
Interest Paid In 30 Years $117,500 $129,500 $166,800

*Interest
rates are for sample purposes only. Your own interest rate with or without points
or credits will vary.

One discount
point typically costs 1 percent of the loan amount and lowers your rate by
about 0.25%.

In this case,
one point costs the borrower an extra $2,500 at closing and lowers their rate
from 3% to 2.75%.

By the end of
year 5, the homeowner has already saved $3,000 in interest compared to the
original rate quote. And the longer they keep their mortgage, the more that
discount point will pay off.

By the end of
year 30, they’ve saved $12,000 compared to the original rate — and nearly
$50,0000 compared to the no-closing-cost mortgage.

This is just
another example of how borrowers can use mortgage pricing to their advantage.

The homeowner
staying long-term can pay for discount points and save themself tens of
thousands of dollars over 30 years. The person buying a starter home or a
fix-and-flip can eliminate their upfront cost and sell before the higher
interest rate starts to matter.

It’s up to you
to decide what makes the most sense based on your home buying or refi goals,
and your personal finances.

Your loan
officer or mortgage broker can help you compare options and choose the right
pricing structure.

Negotiating your interest rate

Both lender
credits and discount points involve negotiating with your mortgage lender for
the deal you want.

You’ll be in a
better position to negotiate low closing costs and a low rate if lenders
want your business. That means presenting yourself as a creditworthy borrower
in as many areas as you can.

Lenders
typically give the best rates to borrowers with a:

Of course, you
don’t need to be perfect in all these areas to qualify for a mortgage. For
instance, FHA loans allow credit scores as low as 580. And if you qualify for a
USDA or VA loan, you can buy with 0% down.

But making
improvements where you can — for instance, by raising your credit score or
paying down debts before applying — can make a big difference in the rate
you’re offered. 

Today’s mortgage rates with lender credits

Today’s rates are still at historic lows. Many
borrowers can get their closing costs paid for and still walk away with a great
deal on their mortgage.

The trick is to compare mortgage loans from a
few different lenders.

If you want a zero-cost mortgage, make sure
you ask specifically for quotes with lender credits so you can find the lowest
rate on the mortgage you want.

Verify your new rate (Feb 25th, 2021)

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