Imagine this: Your search for a home is over, and you’re ready to embark on your home buying adventure. You’re preapproved (or approved) for a mortgage loan, and you’ve got a purchase agreement in your eager hands.
You put the contract down long enough to calculate the final cost of buying the home – and reality hits. From legal fees to title insurance to inspection costs, transfer taxes and filing fees, the costs to purchase the home start to pile up.
After saving for the down payment, these additional costs might cause you some stress. And who needs more stress in their lives? It’s uselessly one letter over the Wordle max and can make the home buying process feel like more of a challenge.
Lender credits, which reduce or eliminate some of the upfront costs of buying a home, may help reduce or eliminate any stress you may be feeling.
Some mortgage lenders offer lender credits to cover all or part of your closing costs. In exchange, the borrower agrees to a slightly higher interest rate on their mortgage loan.
While taking advantage of lender credits to help with closing costs could save you thousands upfront, keep in mind that it may lead to higher monthly mortgage payments, making your mortgage more expensive in the long run.
We’ve got the scoop on how lender credits work. And we promise to share the pros and cons of lender credits to help you decide if they’re the right choice for you.
How Lender Credits Work
With a lender credit, your lender pays for all or some of your closing costs at closing. In exchange, you agree to a higher mortgage rate on your loan.
What lender credits can be used for
You can use lender credits to cover almost all the usual closing costs, including:
- Title or mortgage insurance
- Attorney fees related to the deed transfer
- Prepaid property tax
- Prepaid homeowners insurance
- Lender fees related to the mortgage
- Inspections and survey costs
- Home warranty fees
What lender credits can’t be used for
You can’t use lender credits to cover an expense required to qualify for a mortgage or finance a mortgage. This includes:
- The down payment
- Minimum borrower contributions
- Cash reserves required by the lender
Depending on the lender, lender credits may be an option whether you’re getting a new mortgage or refinancing your mortgage.
Do I have to pay back lender credits?
Well, technically, no – but you do, eventually. You don’t repay lender credits directly. However, you do agree to a higher interest rate on your mortgage in exchange for the credits. The lender recoups the cost of the credits from the “added” interest.
Are lender credits negotiable?
Yes, you may be able to negotiate on lender credits. Depending on your creditworthiness and your lender, you can try negotiating for a higher credit amount or a lower interest rate increase.
Pro tip: If you’re considering lender credits, take a look at your credit score and see if it meets your lender’s requirement or needs some work. The higher your score, the better position you’ll be in to negotiate these details.
How To Know if Lender Credits Are Worth It for You: Pros and Cons
We can’t stress this enough: Lender credits aren’t free. It’s a calculated tradeoff to help make the upfront cost of buying a home affordable.
If all of your available cash is going toward your down payment or other required expenses, lender credits can be the difference between closing on a home or not.
But, if you can afford the closing costs, it may make more sense to pay more upfront in exchange for a lower interest rate over the life of your loan.
What are the benefits of lender credits?
- Lower upfront costs: Lender credits save you money upfront, making the home buying process less expensive.
- Ability to buy a home sooner: If you don’t have to wait because you’re saving for closing costs, you may be able to move into your dream home sooner rather than later.
- Frees up money for a down payment: Because you’re not paying your closing costs, you may have more cash on hand to put toward your down payment, opening doors to various types of funding or higher-priced homes.
- May reduce costs over the short term: If you plan on selling the house soon or refinancing the mortgage in a few years, the tradeoff on lender credits may work to your advantage.
What are the drawbacks of lender credits?
- Higher interest rate: You accept a higher interest rate when you accept lender credits.
- Higher monthly payment: Higher rates typically mean higher monthly mortgage payments. When it comes to affordability, let your budget be your guide.
- Higher overall cost: Depending on how long you keep the mortgage, a higher interest rate can result in paying more for your home loan.
- No down payment assistance: You can’t use lender credits for your down payment.
Let’s see how lender credits work IRL on a $200,000 mortgage.
Without Lender Credits
With Lender Credits
|Mortgage loan amount||$200,000||$200,000|
|Upfront closing costs||$5,000 (paid by you)||$5,000 (paid by the lender)|
|Monthly mortgage payment||$843||$926|
|Total interest paid over a
30-year mortgage (principal not included)
If you accept lender credits on the $200,000 mortgage and decide to sell or refinance the home within the first 3 years, you might be able to save money overall since you wouldn’t have paid back the amount you saved at closing through interest payments, yet.
But, if you plan on keeping the home longer than 3 years, you could save money by paying your closing costs upfront and saving on interest in the long run.
Lender Credits vs. Mortgage Points
Lender credits are not the same thing as mortgage points (sometimes called discount points). In fact, they’re pretty much the opposite.
Mortgage points can help you access a lower interest rate by paying interest upfront when you “buy” discount points.
- Lender credits: You pay less upfront but get a higher interest rate, which means you pay more in interest over the life of the loan.
- Mortgage points: You pay more upfront but get a lower interest rate, which means you pay less in interest over the life of the loan.
Alternatives to Lender Credits
If you’re not interested in lender credits but you still need some help with your closing costs, there are other options to consider:
- Negotiate with the seller: Ask the seller to either pay part of the closing costs or accept a slightly lower price on the home. Either option frees up some of your money at closing. (FYI: This could be a difficult ask in a seller’s market.)
- Apply for closing cost assistance: Apply for programs that help cover closing costs. First-time home buyers may find several available programs. Talk to your mortgage broker about grants and assistance programs in your area.
- Ask a family member for a gift: A relative can gift you money for closing costs (and potentially earn a tax break on the gift). Make sure to document the gift with a gift letter from the gift giver, showing where the money came from and that it is a gift. Talk to your real estate agent or mortgage lender to learn more about using gift money.
- Bulk up your savings: Put off buying a house for a few months or a few years, so you can increase your savings and have more money to cover closing costs.
Lending a Helping Hand To Close the Deal
Lender credits are just one way you can reduce your upfront home buying costs – and maybe even reduce some home buying stress.
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