What Is a Lender Credit on a Mortgage?
Understand mortgage lender credits: how they can reduce closing costs and impact your loan's long-term finances.
A lender credit is a sum of money provided by the mortgage lender to the borrower. This credit helps offset the costs associated with closing a mortgage loan. Closing costs encompass fees and expenses incurred during a real estate transaction. These credits reduce the amount of money a borrower must pay out-of-pocket at closing.
How Lender Credits Operate
Lender credits reduce the upfront cash a borrower needs for their mortgage transaction. When a lender offers a credit, they cover a portion or all of the borrower’s closing costs, which can include fees for appraisal, title insurance, and loan origination. This financial assistance comes with a trade-off for the borrower. In exchange for the credit, the borrower agrees to accept a higher interest rate on their mortgage loan.
This increased interest rate translates into higher monthly mortgage payments throughout the life of the loan. Over the long term, these higher payments mean the borrower will pay more in interest than if they had paid the closing costs themselves. The interest rate increase is tied to the size of the credit received; a larger credit usually results in a more significant rate adjustment. While the immediate financial burden at closing is lessened, the overall cost of borrowing increases over time.
Why Lender Credits Are Offered
Lenders offer credits to make mortgage financing more accessible or attractive to borrowers. A primary motivation is to assist borrowers with limited cash for upfront costs associated with buying a home. Closing costs typically range from 2% to 5% of the loan amount, which can amount to thousands of dollars in addition to a down payment. By providing a credit, lenders enable more individuals to proceed with a home purchase or refinance.
For borrowers, accepting a lender credit can preserve cash. This allows them to allocate funds to other immediate needs, such as emergency savings, moving expenses, or home repairs. Lenders also use these credits to entice borrowers and differentiate their loan products. Lender credits alleviate the initial financial strain of closing.
Evaluating Lender Credits
Assessing a lender credit requires comparing immediate savings against long-term cost. The upfront reduction in closing costs must be weighed against the increased interest payments over the mortgage term. An analytical step involves calculating the “breakeven point,” which is the duration it takes for higher monthly payments to offset the initial credit.
To determine the breakeven point, divide the total amount of the lender credit by the additional amount paid each month due to the higher interest rate. For instance, if a borrower receives a $3,000 credit but pays an extra $20 per month in interest, the breakeven point would be 150 months (3,000 / 20 = 150), or 12.5 years.
If a borrower plans to sell or refinance their home before reaching this breakeven point, a lender credit could be beneficial. Conversely, if they intend to keep the mortgage for a period significantly longer than the breakeven point, the cumulative cost of the higher interest rate will likely exceed the initial credit, making it a more expensive option over time.