What Closing Costs Can Lender Credits Be Used For?

Lender credits are a mechanism designed to assist borrowers with expenses incurred during the home loan process. Understanding how these credits function and what they can cover is important for individuals seeking to optimize their mortgage transaction.

Understanding Lender Credits

A lender credit is money provided by a mortgage lender to a borrower to help offset closing costs. This arrangement is typically offered in exchange for a slightly higher interest rate than the par rate, which is the rate without any credits or points. Its primary intent is to reduce immediate out-of-pocket expenses at closing.

The credit amount is proportional to the interest rate increase; a larger credit often corresponds to a higher rate. These are not cash payments directly to the borrower. Instead, the credit applies directly towards specific fees and costs associated with the mortgage transaction, effectively lowering the cash needed at closing.

Eligible Closing Costs for Lender Credits

Lender credits can be applied to a wide array of closing costs, which are the various fees and expenses associated with finalizing a real estate transaction. These costs typically range from 2% to 5% of the total mortgage amount. They primarily cover non-recurring closing costs, which are one-time fees paid at closing.

Commonly, lender credits cover lender fees, which are charges assessed by the financial institution for originating and processing the loan. These can include origination fees, underwriting fees for evaluating the loan application, and processing fees for preparing loan documentation. Other lender-specific charges, such as commitment fees and document preparation fees, can also be covered.

Credits can also apply to various third-party fees for services from external entities. These include:
Appraisal fees for valuing the property
Credit report fees for assessing the borrower’s creditworthiness
Settlement or closing fees paid to the closing agent
Title insurance premiums (for lender’s and sometimes owner’s policies)
Recording fees to file the deed and mortgage with the local government
Survey fees, if required to confirm property boundaries
Flood certification fees to determine if the property is in a flood zone

While primarily used for one-time closing costs, lender credits can sometimes be applied to prepaid items or escrow amounts under specific conditions. These might include prepaid interest, initial property tax payments, or homeowner’s insurance premiums that are funded at closing. This application is less common and usually occurs if the total credits exceed other non-recurring closing costs, and regulatory guidelines permit such use. Lender credits cannot be used for the down payment or to receive cash back.

Key Considerations for Lender Credits

The total amount of lender credits cannot exceed the loan’s actual closing costs. Any unused credit portion after covering all eligible closing costs is typically forfeited and cannot be disbursed as cash to the borrower. This ensures credits are solely used to facilitate the loan transaction.

Lender credits are transparently disclosed on official loan documents. They appear on the Loan Estimate in Section J under “Total Closing Costs,” shown as a negative number to reflect a reduction in costs. Similarly, on the Closing Disclosure, these credits are listed in Section J, reinforcing the financial arrangement for the borrower. This helps borrowers understand how the credits impact their overall costs.

Credits are specific to the mortgage transaction and not transferable to another loan or party. The trade-off for lender credits is a higher interest rate, resulting in higher monthly mortgage payments and increased interest paid over the loan’s life. While upfront costs are reduced, long-term financial implications should be carefully evaluated.

Lender credits do not have immediate tax consequences for the borrower. They are viewed as a reduction in the overall cost of obtaining the mortgage, not as income. Most mortgage closing costs, except mortgage points and prepaid property taxes, are not tax-deductible.

Lender Credits Versus Discount Points

When originating a mortgage, borrowers frequently encounter two options: lender credits and discount points. Lender credits reduce the upfront cash needed for closing costs in exchange for a higher interest rate over the loan’s term. This can be beneficial for borrowers who prefer to minimize immediate out-of-pocket expenses.

In contrast, discount points are an upfront fee paid by the borrower to the lender, typically 1% of the loan amount per point, to reduce the interest rate. This strategy is often called “buying down the rate.” For example, one point on a $200,000 loan costs $2,000 and might reduce the interest rate by approximately 0.25 percentage points, though the exact reduction varies.

The choice between lender credits and discount points depends on a borrower’s financial situation and long-term plans. If a borrower intends to stay in the home for a shorter period, such as less than five to seven years, lender credits may be more advantageous. This is because savings on upfront costs could outweigh the additional interest paid over that shorter timeframe.

Conversely, if a borrower plans to keep the loan for a longer duration, paying discount points to secure a lower interest rate can lead to significant savings on interest payments over the loan’s life, despite the higher initial cost. The availability of cash for closing costs and the desire for lower monthly payments are also important factors in this decision.