Juanmonino/Getty Images: Illustration by Issiah Davis/Bankrate
Key takeaways
- A lender credit is money you receive from a mortgage provider to help cover closing costs, in return for a higher interest rate.
- While a lender credit helps reduce your upfront homebuying costs, you’ll end up paying more interest on the loan in the long run.
- Lenders determine what kind of credit you might qualify for by assessing factors like your credit score, debt-to-income ratio and down payment amount.
What is a lender credit on a mortgage?
A lender credit is money your lender gives you to help cover your closing costs and reduce the amount you must pay on closing day. In return, you’ll get a higher interest rate on your mortgage.
You’re free to accept multiple lender credits — but the more you take, the more your rate will increase. While these credits lower your upfront costs, you’ll pay more over the life of your loan due to the higher interest rate.
Lender credits can only be applied to closing costs. You can’t put them toward a down payment or use them for any other purpose, including paying down debt to decrease your debt-to-income (DTI) ratio.
How much can a lender credit lower closing costs?
Typically, closing costs range from 2 to 5 percent of your total mortgage amount. So, if you take out a $300,000 loan and your lender offers you enough credits to pay for all of your closing costs, you’d save between $6,000 and $15,000 upfront.
However, the number of credits you’re eligible for — and, therefore, the amount you’d save at closing — is up to your lender.
How are lender credits determined?
Lender credits aren’t available from every lender — and even if a lender offers them, you’ll still have to meet certain requirements to get one. To qualify for a good lender credit and interest rate, you should have:
- A good or excellent credit score
- A down payment of at least 20 percent
- A maximum DTI ratio of 45 percent
Because these credits vary by lender, it’s a good idea to compare offers from different lenders to make sure you’re getting the best deal. If you’re happy with the credit you’ve been offered, you can decide to take it and apply it to your closing costs. Information about the credit will appear in your loan estimate or closing disclosure.
Lender credits vs. points
Mortgage points (also known as discount points) work similarly to lender credits — except in reverse. When you use points, you’ll pay extra money upfront in exchange for a lower interest rate. Generally, each point costs 1 percent of the total loan amount and reduces your interest rate by 0.25 percentage points. For example, one point could lower your interest rate from 7 percent to 6.75 percent.
Sometimes, lender credits are referred to as “negative points,” and you’ll see them listed on your loan estimate as a negative figure. Both points and credits are part of a complex structure mortgage lenders use to price loans.
Example: How lender credits and points impact your rate
Here’s an example to show how using or foregoing lender credits or mortgage points would affect a 30-year, fixed-rate mortgage:
| Without credits or points | With a credit | With one point | With two points | |
|---|---|---|---|---|
| Amount borrowed | $330,000 | $330,000 | $330,000 | $330,000 |
| Interest rate | 6.600% | 6.725% | 6.350% | 6.100% |
| Closing costs* | $7,130 | $6,630 | $10,430 | $13,730 |
| Monthly payment (excluding insurance and taxes) | $2,107 | $2,134 | $2,053 | $1,999 |
| Interest paid in total | $429,167 | $439,272 | $409,486 | $390,441 |
| *Includes a 1 percent origination fee, 1 percent charge for title services, $500 appraisal fee and $30 credit check fee |
As you can see, by accepting a lender credit, you’d save $500 on closing day, but have a higher monthly payment and pay more than $10,000 extra in interest over the course of 30 years.
In contrast, if you pay one point, you’d need to bring $3,300 more to closing, but have a lower monthly payment and save over $19,000 over the life of the loan. With two points, you’d need to come up with $6,600 more in closing costs, but save roughly $39,000 in interest.
How to negotiate a lender credit
Offering lender credits isn’t a requirement for mortgage lenders. That being said, to secure the best deal on a lender credit with a lender that does offer them, keep these tips in mind:
- Before applying, focus on improving your credit score and lowering your DTI ratio (if needed).
- After receiving a lender credit offer from a loan officer, ask if there’s any flexibility with it. Be ready to explain why you think you deserve a better deal, such as having a sizable down payment saved or having a better offer from another lender.
- Before selecting a lender (and its offer), compare lender credit offers from at least three mortgage lenders to ensure you’re getting the best deal.
Are lender credits worth it?
Lender credits can make sense in certain situations, but they aren’t right for everyone. To help gauge if taking a lender credit is right for you, weigh the pros and cons:
Benefits of lender credits
- If you’re strapped for cash, lender credits can help you afford your home purchase.
- If you use lender credits for a refinance, you might reach the break-even point — or the amount of time it takes to recoup the costs of refinancing — faster.
- Your lender might require you to have a specific amount of reserves (cash or other easily accessible assets you could use to make mortgage payments) before it’ll approve the loan. Using a lender credit allows you to maintain those reserves.
- If you expect to sell within a few years of buying, you can enjoy the benefits of the lender credit without making the high-interest payments for the full loan term.
- In the future, if you have the opportunity to refinance to a lower rate, you might be able to mitigate the increased interest caused by the lender credit.
Drawbacks of lender credits
- When you accept a lender credit, your interest rate rises — and that means higher monthly mortgage payments.
- A steeper rate also increases the total amount of interest you’ll pay on your loan term. The additional interest can easily outweigh what you’d save on closing day.
Alternatives to lender credits
If you don’t want to accept the higher rate that comes with a lender credit, consider one of these alternatives:
- Seller concessions: As a buyer, you can ask the seller to pay for a portion of your closing costs. These are known as seller concessions. The seller doesn’t have to agree, but they might do so as a way to sweeten the deal — especially if you’re in a buyer’s market.
- Look for outside assistance: Many cities and states provide down payment assistance (often in the form of low-interest or forgivable loans). You can typically use the funds for a down payment, the closing costs or both.
- Ask for help from family or friends: If you have friends or family willing to lend you money, consider borrowing the closing costs from them. Establish an agreement on when and what will be paid back. If you go this route, you may need to provide your lender with a gift letter explaining where you got the money.
- Consider a no-closing-cost mortgage: These loans come with no upfront fees to pay on closing. Instead, closing costs are rolled into the loan balance. Bear in mind, though, that these mortgages have some of the same drawbacks as credits: They could carry a higher interest rate, and even if they don’t, you’ll pay interest on a bigger loan principal — and so more over the loan’s lifetime, overall.
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