One way to reduce your upfront mortgage costs is with lender credits. A lender credit helps to cover some (or all) of your closing costs, which can save you thousands of dollars. The tradeoff is that you typically must accept a higher mortgage rate.
Whether this compromise is worth it depends on if you can afford the higher monthly payments, how long you expect to keep the mortgage, and more. Here’s what to know about lender credits.
What is a lender credit?
A lender credit covers some of your closing costs in exchange for a higher mortgage rate. In short, it’s an upfront credit that reduces your closing costs but generally causes you to pay more over time. To be clear, it doesn’t reduce your loan balance.
Lender credits differ from seller concessions, which come from the seller. They also differ from closing cost assistance programs, which state or local agencies typically provide. Lender credits come directly from your mortgage lender.
The mechanics of a lender credit
Again, a lender credit will typically lower what you pay at closing, but increase your interest rate. Each institution prices its lender credits differently.
For example, say you’re considering a $400,000 home loan with a 30-year term at 6.75%. A lender may offer you a $4,000 credit in exchange for raising your rate from 6.75% to 7.00%. On that 30-year fixed mortgage, your monthly payment (principal and interest only) would rise about $67 per month. If you kept the mortgage for the full 30-year term, that would amount to an additional $24,055 in interest—a steep price for a $4,000 credit. But if you don’t plan to keep the loan long-term, the credit could work out in your favor.
The break-even analysis: When do lender credits make financial sense?
Put simply, your break-even point is the month in which that extra money you pay each month adds up to the amount you saved in closing costs. After this point, you’d save money by just taking a lower rate and digging deeper into your pockets at closing.
But because you don’t directly pay back lender credits, you can come out ahead if you sell the home or refinance before that magic break-even date. Here’s how to find that date.
Calculating your break-even point
The break-even formula is simple: Divide the upfront credit amount by the monthly cost of the rate increase. The number you get is the number of months until you break even.
Scenario A: The short-term borrower (3 to 5 years)
Let’s use the previous example: A $4,000 credit on a $400,000 loan, assuming an increase from 6.75% to 7.00%, will increase your monthly payment by $67. By dividing $4,000 by $67, you’ll find a break-even point of roughly 60 months. In other words, if you sell or refinance your mortgage before the five-year mark, the credit will have worked in your favor. If you keep the loan longer than that, the higher rate will begin costing you more than the credit saved you.
Scenario B: The long-term homeowner (10+ years)
If you plan to keep your mortgage for much longer than five years, it becomes harder to justify lender credits. The monthly cost of a higher rate will add up over time. Depending on your circumstances, reducing your upfront costs may still be worth paying more in years five to 10. After that, the math becomes hard to justify.
In this situation, choosing a rate without lender credits typically gives you a better long-term outcome.
Strategic scenarios for choosing a lender credit
Lender credits can make the upfront cost of buying a home more manageable. Closing costs on a $400,000 home can run from $8,000 to $20,000. That’s money you’ll have to come up with in addition to your down payment. If the inability to pay closing costs means you wouldn’t be able to take out the loan, a lender credit may be worth considering.
But there are other reasons you might opt for lender credits, too.
Put more money toward the down payment
Freeing up more money can be useful if it’ll help you get to a 20% down payment. On a conventional loan, a 20% down payment can help you avoid private mortgage insurance (PMI), which typically costs between 0.46% and 1.5% of the loan amount per year. That cost can add up: On a $400,000 loan, PMI could cost between $1,840 and $6,000 per year.
Keep money in cash reserves
If ponying up for closing costs will virtually zero out your cash reserves, you may also want to consider lender credits to preserve some savings. An emergency fund can help you weather rough times and stay current on your loan.
Where to find credits on your loan documents
Scan your Loan Estimate to find “Section J.” This is your total closing costs. You should see the “Lender Credits” line. The amount on this line is a negative number, which reduces the estimated cash you’ll need at closing. If you’ve discussed a credit with your lender and they haven’t included it on the Loan Estimate, it’s important to resolve that issue before the loan moves forward.
Your Closing Disclosure should also show the lender credits you’ve agreed to. If your lender is covering a specific fee, you could instead find it next to that fee in the “Paid by Others” section.
Before you sign, compare your Loan Estimate and Closing Disclosure side by side. Ask your lender to explain any meaningful differences, especially if the lender credit changed. You should receive the Closing Disclosure at least three business days before closing, giving you time to make sure your lender applied the credit correctly and review the final costs.
Limits on lender credits: What you need to know
There’s no single maximum lender credit for everyone. The maximum amount you can apply toward closing costs can’t be greater than your eligible closing costs. If a credit exceeds that number, you won’t receive the excess in cash. However, your lender may apply it to your mortgage principal, depending on the loan program. For this reason, it’s best to select a credit that’s as close as possible to what you actually expect to pay.
Remember, lender credits typically mean a higher interest rate—which means a higher monthly payment. If you’re already close to your lender’s DTI limit, a higher payment could make it harder to qualify.
Before you accept a lender credit, it’s worth asking your loan officer to show you how the higher rate would affect your DTI.
How to negotiate lender credits
Timing your request: From pre-approval to rate lock
You may find it easier to negotiate lender credits before you lock in your rate, while you’re still comparing offers from multiple lenders. Ask each one for a Loan Estimate, then compare the lender credits as well as the rate and fees. You can use offers from other lenders to leverage a better offer with your preferred lender.
Comparing loan offers across lenders
Annual percentage rate (APR) shows the yearly cost of borrowing money as a percentage. It includes things like interest, mortgage broker fees, and other lender charges, which can help you compare mortgage offers.
Still, it doesn’t tell you whether a loan is the best deal for your timeline.
Instead, compare each offer based on how long you plan to keep the loan. Page 3 of the Loan Estimate includes a section called “In 5 years.” You can subtract the principal you’ll have paid from the total paid over five years to learn your estimated interest and fees over that period.
The takeaway
Before you take a lender credit, consider the following:
- How long do you expect to keep the loan?
- Is the money you’re saving at closing worth the higher monthly payment?
A loan officer can show you a few versions of your loan to help you compare different lender credit amounts. Each option will result in a different interest rate, monthly payment, and break-even point.
Just remember—lender credits tend to work best if you plan to sell, refinance, or pay off the loan before that break-even point. After that, the higher rate will begin costing you more than the credit saved you.
Frequently asked questions
Are lender credits worth it if I plan to refinance soon?
Possibly. Lender credits may be worthwhile if you refinance before your break-even point. After that, you may begin paying more than you’ve saved with credits.
Do lender credits affect my debt-to-income ratio?
They can. Lender credits typically increase your interest rate and monthly payment, which can also increase your debt-to-income ratio (DTI).
What is the difference between lender credits and discount points?
Lender credits lower your upfront costs by increasing your mortgage rate. Mortgage discount points increase your upfront costs and lower your mortgage rate.
What is a “par rate” on a mortgage?
A “par rate” is a mortgage rate without lender credits or discount points. You don’t pay extra to lower the rate or accept a higher rate to reduce your upfront costs.
How much can I get in lender credits?
There’s no single limit. The amount available depends on factors like your loan amount and interest rate. That said, lender credits generally can’t be more than your eligible closing costs.