What Is A Lender Credit On A Mortgage?
If you take out a mortgage to buy or refinance a home, you’ll have to pay closing costs. These usually range from 3% to 6% of the total loan amount, which can add up to thousands of dollars.
In some cases, you might be able to use a credit from your lender to cover some or all of your closing costs—this is sometimes known as a no-closing-cost mortgage. If you’re wondering what a lender credit is and if using one is right for you, here’s what you should know.
What Is a Lender Credit?
A lender credit is money provided by your mortgage lender to help cover a certain amount of your closing costs. However, this kind of credit isn’t just free money. In exchange, you’ll agree to pay a higher interest rate on your loan, which likely means making higher monthly payments.
Keep in mind that while a lender credit can cover a variety of closing costs, you can’t use one for:
- A down payment
- Funds pay off other debts to allow you to qualify for a mortgage
- Cash reserves to show you have the ability to repay the loan if your income changes
How Does a Lender Credit Work?
With a lender credit, the lender will cover your closing costs. In return, you’ll be charged a higher interest rate over the life of the loan, which will allow the lender to recoup the money it fronted you along with additional interest.
For example, say you’ve been approved for a $200,000 mortgage with an interest rate of 5% and a repayment term of 30 years, and your closing costs are estimated to be $8,000. You don’t have $8,000 on hand, so you ask the lender for a lender credit. The lender agrees to cover the $8,000, but in return, your rate will increase to 6%.
The good news is that you’re off the hook for the initial $8,000. The bad news is that your mortgage payment will increase by about $100 per month.
Also note that a lender credit can be structured in a few different ways. For example, it might cover:
- All of your closing costs
- The lender’s own fees and its third-party services
- Only the lender’s fees
How Much Can You Get With a Lender Credit?
The exact amount you’ll be able to get with a lender credit will depend on the individual lender as well as the type of loan you’re getting and your loan amount. If you’re interested in a lender credit, be sure to shop around and compare your options from as many mortgage lenders as possible.
Are Lender Credits Worth It?
Whether a lender credit is worth it will depend on your individual circumstances and financial goals. For example, if you have little cash on hand for closing costs or prefer to retain your savings, then utilizing a lender credit might make sense. However, accepting a higher interest rate means your monthly payments will likely increase, which can add up to thousands of dollars over time.
But if you don’t plan on staying in the home for very long, this might not be as much of a problem. In this case, you’ll need to consider how many months it will take for your lender credit to be offset by the higher monthly mortgage payment—and whether this is worth it compared to paying your closing costs on your own. You can use our mortgage payment calculator to estimate your payments with various rates to get an idea of what to expect.
How to Negotiate Lender Credits
Lender credit offerings vary by lender. But if a lender wants your business, it might be willing to negotiate your interest rate, which in turn could make a lender credit less expensive. You’ll generally be in a better position to negotiate with a lender if you meet some or all of the following criteria:
- Good to excellent credit (a credit score of 720 or higher is preferred)
- Clean credit report without a history of late payments
- Down payment of 10% to 20% of your loan amount (or more)
- Debt-to-income (DTI) ratio below 43%
- Loan amount within conforming loan limits
Making improvements where you can make a big difference in the rate you’re offered. For example, you could work on paying down debts to increase your credit score and decrease your DTI ratio.
Lender Credits vs. Discount Points
Another term you might come across when applying for a mortgage is “discount points.” These work opposite to lender credits. Instead of paying less upfront in exchange for a higher rate, you’ll pay more upfront to get a lower rate. While you’ll have higher upfront costs with discount points, you’ll also save money on interest over the life of the loan.
Paying for discount counts could be worth it if you plan on staying in your home for the long term, want to reduce your interest costs and can afford the upfront expense. You can generally expect one discount point to equal 1% of your loan amount, which in turn will knock about 0.25% off your rate.
But if you won’t be living in the home for long or can’t afford to cover your closing costs, then opting for a lender credit might be a better option.