What Is a Lender Credit and How Does It Work?

A lender credit is a financial arrangement where a mortgage lender provides money to a borrower to help cover a portion of their closing costs. This credit effectively reduces the amount of cash a borrower needs to bring to the closing table. In exchange for this upfront financial assistance, the borrower typically agrees to a slightly higher interest rate on their mortgage loan. This mechanism helps make homeownership more accessible by lessening the immediate financial burden at the time of loan finalization.

How Lender Credits Are Applied

Lender credits are specifically designed to offset various expenses incurred at closing. These costs often include charges for services such as loan origination (0% to 1% of the loan amount), appraisal fees ($500-$800), and title insurance premiums (0.1% to 2% of the home’s purchase price, or between $500 and $3,500).

Lender credits can be applied to recording fees, attorney fees, and underwriting fees. For instance, if closing costs total $10,000 and the lender offers a $3,000 credit, the borrower would only need to pay the remaining $7,000 out of pocket.

Lender credits have specific limitations on their use. They can only be applied toward eligible closing costs and cannot be used for the down payment on the home. Similarly, a borrower cannot receive cash back from a lender credit; any excess credit beyond the closing costs is typically not refundable.

Understanding the Implications of Lender Credits

The primary implication of accepting a lender credit is the adjustment to the mortgage interest rate. Lenders offer these credits by essentially building the cost into the long-term interest rate of the loan. This means that while immediate upfront costs are reduced, the borrower will pay a slightly higher interest rate over the loan’s repayment period.

A higher interest rate translates to higher monthly mortgage payments and a greater total amount of interest paid over the life of the loan. Even a small increase in the interest rate can significantly affect the overall cost, especially on a long-term mortgage such as a 30-year loan.

The lender credit amount is directly tied to the interest rate selected by the borrower. Borrowers seeking a larger credit to cover more closing costs will be presented with a higher interest rate. Conversely, opting for a lower interest rate might mean receiving a smaller lender credit, or no credit at all.

Lender Credits Compared to Discount Points

Lender credits represent one side of a financial strategy, while discount points represent the opposite. Discount points are fees that a borrower pays upfront to the lender to reduce their mortgage interest rate. This means a borrower pays more cash at closing with discount points in exchange for lower monthly payments and reduced total interest over the loan’s term.

In contrast, a lender credit means the lender provides funds to reduce upfront closing costs, but the borrower accepts a higher interest rate. Therefore, discount points increase upfront costs to lower long-term interest, while lender credits decrease upfront costs in exchange for higher long-term interest. This inverse relationship is why lender credits are sometimes referred to as “negative points.”

Both options allow borrowers to adjust the balance between upfront expenses and long-term interest costs. The choice between accepting a lender credit or paying for discount points depends on a borrower’s financial liquidity and their plans for the property. A borrower with limited cash for closing might prefer a lender credit, while one planning to stay in their home for many years might find discount points more beneficial due to the long-term interest savings.