Defining lender credits
In the typical process of buying a home, some secondary steps need to be taken before you reach a sales agreement — and all of them cost money. These include the following:
- Final home appraisal
- Origination fees
- Home inspection
- Flood certification
- Escrow fees
- Title insurance
- Fees owed to attorneys, couriers, and other officials involved in the sale
Lenders usually combine these fees into a single closing cost for the buyer to pay before officially getting the property. The price might take you by surprise; closing costs typically make up between 2% and 6% of the homebuyer’s total loan amount. After all the expenses you’ve already paid, chances are the lender is going to verify the borrower’s assets prior to closing and communicate this to them so they are not short at closing.
To lower the stress on your finances, a mortgage lender may offer credits to homebuyers like yourself. These lender credits cover all or part of the closing costs at the final transaction. The more lender credits you receive, the more money you’ll save on closing costs when buying your home.
Lender credits don’t come for free, though. Instead, lender credits pay for your closing costs in exchange for higher interest rates for the life of the loan. Thus, if you’re buying a home and accept a higher interest rate, you will end up with a higher monthly mortgage payment.
First-time homebuyers need to understand that taking lender credits does not make the closing costs disappear. You’ll still pay for them as part of your loan balance through the higher monthly payments. This can add up to thousands of dollars over a standard 15- or 30-year mortgage agreement.
How do lender credits work?
Are you a homebuyer who is looking to save on upfront costs via lender credits? Here’s a step-by-step guide for doing just that.
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Find out how your lender offers credits
Lender credits are calculated into your loan estimate as part of your mortgage agreement. The first step is to find out whether your chosen mortgage lender offers to front some of your closing costs in exchange for a higher interest rate.
If you haven’t yet decided on your mortgage lender, research your top options.
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Get pre-approval for the loan and lender credits
A mortgage pre-approval agreement will explain how lender credits are applied to your closing costs. You can ask your lender about what lender credit options you have. If possible, ask for multiple loan scenarios and calculations to get the best repayment terms in light of the credits.
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Receive the lender credit
Finally, your lender will issue a loan estimate that spells out the terms of your loan, incorporating the lender credit. They’ll then send a closing disclosure that breaks down every element of your final costs. After signing the final loan documents, your lender credit kicks in. You’ll pay a higher interest rate on your loan balance going forward.
Lender credits for first-time homebuyers
Lender credits can be particularly useful for first-time homebuyers or lower–income borrowers. They are an opportunity to put extra cash in buyers’ pockets for homeowner expenses outside of closing costs and down payment. Lender credits can provide extra funds for essential purchases like furniture or patio sets, easing financial strain during the homebuying process.
Can you negotiate lender credits?
In some situations, a homebuyer may have the chance to negotiate the amount and interest they’ll owe on lender credits for the remainder of their loan. This usually happens during the application process.
Check to see what conditions your mortgage lender favors when calculating lender credits.
Pros and cons of lender credits
As is the case with most homebuying scenarios, lender credits come with a range of advantages and disadvantages to the borrower.
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Pros
Some of the benefits of lender credits include:
- Upfront cash savings: More cash in your pocket after closing costs
- More cash for down payments: Paying more of the home price can make private mortgage insurance unnecessary
- Potential tax savings: You can claim more deductions on mortgage interest
- Savings on resale: If selling the property after a short time, your higher-interest monthly payments are canceled, saving you money
Consider these potential benefits carefully.
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Cons
Some of the possible pitfalls of lender credits include the following:
- Higher interest rates: Higher interest means higher mortgage payments
- Potential closing cost exceptions: May not cover every single closing cost
- Higher debt-to-income ratio: Ongoing higher payments can increase debt in proportion to your income
It’s best to review all potential drawbacks of lender credits before you accept them.
Lender credits vs. discount points
Another option for saving money is through discount points, also known as “mortgage points.” These effectively work in reverse from lender credits.
With discount points, you pay more in upfront costs when you borrow to lower interest rates on your future monthly payments. Each point you buy reduces your interest by a fraction — typically, but not always, 0.5% per point purchased.
Discount points are more beneficial for buyers with more cash to afford the higher upfront costs. For that reason, they may not be appropriate if you are someone who’s looking into lender credits to cut your upfront costs. That said, if you have any flexibility with your budget, you could look into structuring discount points to save in future payments.
Are lender credits worth it?
Altering or customizing your mortgage repayment agreement in any way will affect your budget and future financial standing. That’s why it’s so important to think deliberately about whether lender credits will help or hurt your family’s finances in the long run. Lender credits are not gifts or “free money” — they simply alter the terms of future repayments.
If you find yourself strapped for upfront cash to buy or refinance your home, lender credits may be the solution for you. And if you’re a first-time homebuyer, they can help you save some of your finances for emergency or repair funds. Talk to your mortgage lender about whether lender credits will help you achieve the American dream of homeownership once and for all.
