What Are Lender Credits And How Do I Get Them?
7-minute readJanuary 25, 2021
Buying a home is an expensive endeavor. From coming up with a down payment to paying for a home inspection and moving costs, there are expenses everywhere you turn. Additional costs may feel stressful if you have used every penny you have to afford your dream home. You may also experience some shock when you review your closing contract with all your closing costs.
If you’re worried about paying for those extra expenses, there’s a solution to help ease this financial burden: lender credits. Read on to discover how lender credits work and how they may be able to help you afford your closing costs.
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What Are Lender Credits?
Did you know your closing cost can tack on an additional 3% – 6% of the total purchase price of your home? If you decide to purchase a $200,000 home, you could be looking at paying upwards of $12,000 in closing costs alone. If you haven’t set this money aside, some lenders offer lender credits to help offset the cost.
Here’s how it works. The lender will charge a higher interest rate in exchange for funds to offset your closing costs. When you use lender credits, you may pay less upfront but more over the longevity of the loan. The more lender credits you receive, the higher your interest rate will be.
Your interest rate will depend on your lender, the type of loan you apply for, and the mortgage market condition at the time of your application. Every lender has a different fee and pricing structure. So, even if you receive lender credits from one lender and receive a higher interest rate, you may be able to get a lower interest rate with the same amount of lender credits at a different financial institution.
What Are Discount Points?
Discount points are another option borrowers use to help offset the cost of buying a home. If you can afford your closing costs but want to lower your overall interest rate, consider this option. With discount points, the lender trades higher upfront closing costs in exchange for a lower interest rate. This allows the borrower to save money over the term of the loan. Points are a good option for homeowners who think they will need their loan for a long time.
Lenders calculate points in relation to your total loan amount. Typically, each point equates to 1 % on the loan balance. For instance, one point on a $200,000 loan would be $2,000 or 1%, while two points would be $4,000 or 2% of the balance. If you choose to buy points, your points will be due at closing.
You can determine if points are right for you by doing a little bit of math. Let’s say that buying two points upfront on a $200,000 loan saves you $40 per month on your payment. Two points would be $4,000. If you divide that cost by your monthly savings, you get the break-even point in a certain number of months. In this case, it would take you 100 months – a little over 8 years to break even. After that point, you start making money over the life of the loan.
It’s important to know that points are sold in increments of 0.125% of your loan amount, so you don’t have to buy whole points to consider the option.
Like lender credits, your points are determined by the lender, the type of loan and the current mortgage conditions.
How Do You Get Lender Credits And Discount Points?
When shopping for a mortgage, you have a lot to consider. You want to compare the lender’s interest rates, fees, loan-to-value criteria and the number of discount points or lender credits paid. So, before you get hooked on one lender, ask about their discount points and lender credits and how their process works. Each lender may have a different point structure and criteria for receiving points or credits.
Understanding lender details upfront will help you make a more educated decision when you go to select the best mortgage lender.
Can Lender Credits Be Used For The Down Payment?
According to Fannie Mae, you cannot use interested party contributions for financing or sales allowances. That said, Fannie Mae considers all lender credits to fall under the IPC category. This means that you cannot use lender credits for a down payment. In addition to funding down payments, you cannot use lender credits for financial reserve requirements or minimum borrower contribution requirements.
Although we’ve used Fannie Mae as an example here, the policy of having your own funds for a down payment or reserves is consistent across all major mortgage investors.
What Are Mortgage Points?
While there’s not a lender credit tax deduction, you can claim prepaid interest as an itemized deduction on your Form 1040 Schedule A. If you decide to use discount points to lower your interest, you may be able to deduct all points paid on the mortgage. The IRS uses the term points to refer to charges paid to obtain a mortgage.
However, if your home debt exceeds the allotted amount, you may not be able to claim all of your mortgage interest and points. But, you can deduct points over the term of the loan or when you paid for them.
There are specific rules governing whether you can deduct your mortgage points in the year you paid for them or whether they must be deducted in equal amounts over the life of the loan. Consult a tax professional if you’re unsure of the proper course of action.
How Much Do Lender Credits Cost?
Now that you understand how to use lender credits and points, you may be wondering how they could impact your finances. Let’s say, for example, you borrow $180,000 and qualify for a 30-year fixed mortgage with a 5% interest rate with no points or lender credits.
If you decide, however, that you want to keep your mortgage for a long time and you can pay more closing costs upfront, you may choose to use 0.375 points toward your interest rate. This would then give you an interest rate of 4.875%. You may agree to pay $675 in extra closing costs to shave off $14 a month on your mortgage payment.
On the other hand, you may decide you don’t have enough cash to afford all the closing costs and decide to apply for lender credits to offset the expenses. In this case, increasing your interest rate to 5.125%, the lender may pay $675 now to help with closing costs. However, your mortgage payment would increase $14 a month.
As you can see, both situations can impact your finances in different ways. Everyone has a different financial status requiring a different recommendation. Therefore, it’s important to evaluate what may work best for you now and in the long run.
When Should You Use A Lender Credit?
Lender credits come with some advantages. In certain situations, it may make sense to use lender credits toward your closing costs. For instance, if your down payment and other home buying costs have spread your finances too thin, you may consider lender credits to help ease the financial burden of your closing costs. Using lender credits in this situation can help you avoid financial stress and make your budget go further. For some, coming up with $5,000 may be more challenging than paying an extra $15 a month.
Additionally, if you don’t plan on staying in your home for the entire term of the loan or if you’re considering refinancing, the use of lender credits may make sense. The small increase to your interest rate may not affect you in the short term.
The Bottom Line
Buying a home is a big commitment that comes with a lot of financial responsibility. So, before you venture out to purchase your dream home, you must understand how much it will cost. Compare lenders and mortgage options to ensure you select the most suitable loan that fits within your budget.
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