What Are Lender Credits?

What Are Lender Credits?

Lender credits allow the lender to cover some or all of your closing costs—fees and expenses you pay when you sign your mortgage paperwork. Closing costs usually range from 2% to 5% of the home's purchase price and are paid in addition to your down payment.

In return for the lender credits, you accept a slightly higher mortgage rate than you might otherwise qualify for. The trade-off can reduce the amount of cash you need at closing, making it easier to finalize your home purchase.

How Do Lender Credits Work?

With lender credits, your out-of-pocket expenses at closing are reduced because the lender covers some of your upfront costs. This can include common fees, like:

• Appraisal fees
• Title insurance
• Loan origination fees
• Attorney fees

In return, the lender increases your interest rate. This means your monthly payment will be slightly higher and you'll pay more interest over the life of the loan. The size of the credit and the rate increase are directly linked: The more lender credits you take, the higher your interest rate will be.

The exact amount of lender credit offered and the rate increase depends several factors, including:

• Your credit score
• Your down payment
• Your debt-to-income ratio (DTI)
• The loan program
• The lender

Lender credits are available for a variety of mortgage loan types, including conventional, Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans. Not all lenders offer them, so it's worth shopping around or working with a mortgage broker if you're interested in using lender credits.

Tip: Working with a mortgage broker gives you access to a wide network of lenders and someone who can compare options on your behalf.

Lender Credits vs. Mortgage Points

Lender credits and mortgage points are opposite in how they affect your loan. Lender credits lower your upfront costs, but increase your interest rate. Mortgage points require you to pay more at closing in exchange for a lower interest rate.

Buying mortgage points can lower your monthly payment and may offer potential tax benefits. However, it also means using more cash at closing, and you may not break even if you sell or refinance within a few years.

In some cases, lender credits can also be used to reduce your rate. If the credit you receive exceeds your total closing costs, the remaining amount may be used to buy down your interest rate. This depends on your lender and loan program.

Learn more: Are Mortgage Points Worth It?

Pros and Cons of Lender Credits

It's important to weigh the benefits and drawbacks before choosing lender credits:

Should You Get Lender Credits?

It may be a good idea to get lender credits if any of the following apply to you:

• You're short on cash for closing. Lender credits can reduce or eliminate upfront expenses at closing, making it easier to move forward with your home purchase.
• You plan to sell or refinance soon. A higher rate matters less if you won't keep the mortgage long term. You benefit from lower upfront costs without paying the long-term cost of the higher interest rate.
• You want to keep funds available for other goals. Your cash may be better spent paying off high-interest debt or investing. Even with a slightly higher mortgage rate, you may come out ahead financially.
• You're getting a smaller loan amount. The monthly payment increase may be more manageable on a lower mortgage amount. A 0.5% increase in interest rate adds about $40 per month to a $120,000 mortgage and around $80 per month to a $240,000 mortgage, based on a 7.25% starting rate.
• You can afford a higher monthly payment. If the additional monthly cost won't significantly impact your budget, using lender credits can provide more flexibility with your savings.

How to Negotiate Lender Credits

Here are some tips for negotiating lender credits:

• Shop around. Get quotes from multiple lenders and compare both interest rates and credit amounts.
• Ask for a credits versus no-credits breakdown. Ask for lenders to show you the rate with and without credits so you can see the tradeoff.
• Play with the numbers. Use a mortgage calculator to understand your long-term costs based on your home ownership timeline.
• Bundle negotiations. You may have more room to negotiate credit amounts if you're also negotiating other things like points or lender fees.
• Focus on the big picture. Accepting a small credit that increases your rate significantly may not be worth it, especially if making the higher monthly payments is a stretch.

Learn more: Can You Negotiate Mortgage Rates?

Alternatives to Lender Credits

If lender credits aren't available or don't make sense for your situation, here are a few alternatives to consider:

• Seller concessions: The seller may agree to cover some of your closing costs as an incentive to close the deal.
• Rolling closing costs into the loan: You may be able to include closing costs in your mortgage loan. This will increase the amount you're borrowing and total interest paid, however, so do the math before making a decision.
• Down payment assistance programs: Many states and cities offer grants, forgivable mortgages or tax credits for qualified borrowers. Down payment assistance can reduce how much you have to pay for down payments and closing costs.
• Gift funds from family: You can often use gift money to cover your closing costs or down payment as long as the gift follow's the lender's guidelines.

The Bottom Line

Lender credits can help lower your upfront homebuying costs, especially if you have limited savings or you're planning to move or refinance in a few years. Before moving forward, consider your budget, timeline and financial goals to decide whether this is the right option for you.

Make sure your credit score is good to improve your chances of qualifying for favorable terms. A higher score can help you qualify for a more competitive interest rate, making it easier to absorb the small rate increase that comes with lender credits.