What are lender credits used for when buying a house?

If you’re in the process of closing on a house, you may be wondering if lender credits could be right for you. Lender credits let you roll your closing costs into your loan. In exchange for not paying these costs upfront, your lender charges you a higher interest rate over the life of your loan.

If you’re feeling daunted by factoring closing costs into your house buying budget, lender credits could seem like a tempting way out of a bind. But are they worth the cost? In this article, we’ll look at the benefits and drawbacks of lender credits when buying a house, and help you decide whether taking lender credits is right for you.

What is a lender credit?

During the last stages of your loan, your mortgage lender will pay for necessary services such as a home appraisal and any pest inspections that your state may require. The lender then charges these services to you in the form of closing costs.

If your lender offers you credits, it means they’ll absorb your closing costs and shoulder the costs themselves. In exchange, you pay less upfront but agree to take on a higher interest rate than you would get if you were to pay the closing costs yourself out of your own funds.

The amount that your interest rate increases depends on how many credits you take. The more credits you accept, the more money your lender will “credit” you for your closing costs – and the higher your new interest rate will be.

Lender credit vs. mortgage points

Mortgage lender credits are essentially the opposite of mortgage points. As we’ve discussed, lender credits allow you to pay less upfront in exchange for a higher interest rate over the life of your loan. On the other hand, mortgage discount points allow you to pay a one-time fee that you pay upfront in order to lower your interest rate. 

How are lender credits determined?

Lender credits are generally determined and calculated as a percentage of the loan amount.

Both lender credits and mortgage points will appear on your Closing Disclosure or Loan Estimate if you choose this option. By speaking with a loan officer or mortgage broker, you’ll be able to determine what option is the most suitable for you.

Closing costs can be more expensive than you might anticipate. They typically equal 3% – 6% of your total loan value when purchasing a home. That means if you buy a home with a $200,000 loan, you can expect to pay an additional $6,000 – $12,000 in closing costs. These costs come in addition to anything that you pay in a down payment.

Expensive closing costs can make lender credits tempting. However, these credits may not be as advantageous as they appear.

Are lender credits worth it?

Lender credits can provide a great opportunity for home buyers short on cash. For example, if you’re a first-time home buyer and would prefer to have some emergency cash available, or if you’re starting a savings account for home maintenance costs, using lender credits could help you put the money you’d otherwise spend on closing to good use.

However, it’s important to remember that lender credits aren’t free money. You pay for anything you take out in credits over the course of your loan when the lender increases your interest rate.

Your monthly mortgage payment may only increase by a few dollars each month, but this small increase can add up to thousands of dollars in a short amount of time. Let’s look at an example.

Lender credits example

Let’s say you want to buy a home with a $200,000 principal loan balance and a 30-year term at 6%. Your lender tells you that when you close, you’ll need to pay $6,000 in closing costs. You can take on an interest rate of 6.25% if you don’t want to cover your closing costs.

Mortgage costs with lender credits

If you take the lender credit, the only thing you need to pay for is a down payment in exchange for accepting higher interest rates. You may not have this money on hand after calculating your down payment, so you decide to take the lender credits.

Your monthly payment is $1,231 because you took the lender credits. By the time your loan matures and you own your home, you’ll have paid your lender $243,316 in interest.

Mortgage costs without lender credits

Now, let’s look at what you’d pay if you had covered your own closing costs. You’d pay $6,000 to your lender upfront and get a 6% rate – paying your own closing costs means a lower interest rate. In this example, your monthly payment would be $1,199. That’s $32 less per month than the higher APR.

Over the course of your loan, you pay a total of $231,676 in interest, which is $11,640 less than what you’d pay with lender credits. Even after you subtract the $6,000 you paid in closing costs when you took your loan, this loan is $5,640 less expensive. Even a small increase in your APR makes a big difference in the total amount you end up paying.

Benefits of lender credits

Lender credits can offer some powerful benefits, especially if you’re short on cash. Here are some reasons why using lender credits might make sense.

You pay less upfront to your lender

The major benefit of lender credits is that they allow you to close on your mortgage loan without paying thousands in closing costs. The average home buyer pays about 3% – 6% of their loan’s value in closing costs, which can quickly add up to thousands of dollars. The amount paid in closing costs will vary by location and buyer circumstance.

You may be able to buy a home sooner

Credits can mean the difference between closing now and more months of saving. Depending on the cost of your rent, the additional cost in interest could be partially offset by savings in monthly rent payments.

More money can go to your down payment

When you use lender credits, you can apply the money you would have paid in closing costs toward your down payment. This can be more financially beneficial for you in a couple ways. First, the higher your down payment, the lower your potential interest rate. Additionally, the premiums for private mortgage insurance (PMI) are bucketed based on the size of your down payment. If you can make a slightly higher down payment to get into a lower bucket, you may not have to pay as much for PMI.

You may be able to avoid PMI

If you’re getting a conventional loan, your lender will require you to pay PMI if you don’t have at least 20% to put down on your home. PMI is a type of protection that safeguards your lender if you stop making your loan payments. If your lender credits allow you to put the full 20% down on your home, you can avoid having to pay PMI on your mortgage.

Your monthly payment may only increase slightly

Depending on how many credits you take, your monthly payment may only rise by a few dollars. Using the example above, if you’re like most home buyers, paying an extra $32 a month toward your mortgage is much more feasible than coming up with $6,000 or more to close.

You can save money if you sell soon after buying

The main drawback of the higher interest rate that results from using lender credits is that you pay more for your loan as it matures. However, if you plan to sell your home or refinance in a few years, the higher interest rate is less of a concern. You might end up paying just a few hundred dollars more in interest. When you compare this amount to the thousands you may pay when you close on a house, you save money using credits. Just remember that refinancing has closing costs as well.

Drawbacks of lender credits

There are a few factors to consider before you accept those credits:

You could pay thousands more for your loan

Using credits can save you money if you’re only planning on living in your home for a few years. However, if you live there for a long time, you’ll end up paying more over the life of your loan. Even a small percentage increase can mean spending thousands more on a home loan. This is especially true if you take on a 30-year mortgage. The longer you plan on living in your home, the more you’ll pay in interest.

You could pay more on future closing costs

Planning to refinance your loan in a few years when interest rates drop? Remember that the cost of refinancing includes closing costs. When refinancing, you can expect to pay 3% – 6% of the total value of your loan, depending on your location and other factors. Since lender credits raise the loan's value, they’ll also raise the price of future closing costs, which will be a percentage of that loan.

Other ways to save on closing costs

There are other, more affordable ways to save on closing costs besides taking on a permanently higher interest rate. For example, you can ask the seller to pay a percentage of your closing costs.

If the seller really wants to close the sale, they may be willing to pay a portion of your closing costs to seal the deal. This is known as a seller concession. Alternatively, if your seller doesn’t have the cash on hand, you may be able to convince them to accept a lower final selling price.

You can then divert that money toward your closing costs. These creative solutions save you money on interest and lessen the burden of closing costs.

How to negotiate lender credits

If you’re considering using lender credits, it’s important to know that various lenders offer different interest rates and credit amounts based on numerous factors. In fact, some lenders may not offer credits at all, as they aren’t required to do so. Start by asking your lender whether they offer credits and how much you can save upfront by using them. Then, consider comparing offers from various lenders to see who will give you the most in credit for the best interest rate.

The bottom line: Lender credits help you save on closing costs

Lender credits can save you money if you plan to live in your home for only a few years. Your monthly payment may only increase by a few dollars a month, which you might find more realistic to pay compared to thousands at closing.

However, interest adds up if you live in your home for a longer period. Consider asking your seller to cover a portion of your costs if you want to save on closing costs without accepting a higher interest rate.

If you’re ready to begin the home buying process, apply for your initial mortgage approval online today.