What are lender credits and how do they work?

Sitting at a mortgage closing table can be an emotional experience—feeling a mix of excitement, happiness, and even a little nervousness when finalizing such a significant transaction is totally normal. But there’s one part of the process that can spark a not-so-warm-and-fuzzy feeling: closing costs.

Closing costs, as the name suggests, are due in full at closing. If you’re daunted by this, you’re not alone. Most buyers want to do everything they can to reduce the amount they pay upfront to purchase their home. Here’s how you can use credits to do just that.

What is a lender credit?

There are several ways to mitigate out-of-pocket expenses when closing on a real estate transaction. If you’re buying a home, for example, you can try negotiating with the seller to see if they’ll agree to cover a portion of your closing costs. If you’re refinancing, you may be able to “roll in” your closing costs on top of your new mortgage loan balance.

Another popular way to reduce closing costs is by accepting lender credits. In this scenario, your lender covers some or all of your closing costs. In return, you agree to pay a higher interest rate on your loan. Sounds nice, right? For some borrowers, it makes sense to rely on lender credits but for others it might actually cost them more money in the long run/ Here’s how to determine if credits are right for you.

How do lender credits work?

When you buy or refinance a home, your mortgage payments mainly go toward paying down the principal balance and interest. But there are also one-time upfront costs associated with financing a home. Enter, closing costs.

Closing costs are a normal part of buying and refinancing real estate. They can consist of third-party fees like title insurance and escrow fees, lender fees, and any other required prepaid items such as property taxes and homeowners insurance.

As you might expect, these costs can quickly add up. As a general guideline, homebuyers should expect to pay between 3% and 8% of a loan’s value in closing costs.

To alleviate the short-term financial burden of closing costs, some buyers choose to accept lender credits rather than footing the bill upfront. When applying credits to a transaction, lenders agree to absorb a percentage of closing costs. They recoup these temporary losses by charging a slightly higher interest rate than if no credits were applied to a loan.

Lender credits can also be advantageous to borrowers in certain circumstances.

How do credits work for purchasing a home?

If you’re thinking about buying a home, the first thing you should do is begin to understand your budget. Based on your financial goals, how much can you afford to spend per month on your mortgage? Lender credits can help homebuyers who might not want or be able to spend as much money upfront.

If you have fewer savings set aside for closing costs (or just prefer to keep money in your pocket for moving expenses) it might make sense to request that your lender cover those upfront expenses in exchange for a higher interest rate on your loan. However, if your mortgage payment is already at the top end of your budget, it might not be financially advisable to add a higher rate just to avoid some upfront costs.

Exploring all your options as soon as you can will help you choose the type of mortgage and loan terms that make financial sense for your situation. If you’re already under contract, you can still ask whether your lender is willing to offer a mortgage credit.

How do credits work for refinancing a home?

When you refinance, you’re essentially swapping out your old mortgage for a new one (ideally with more advantageous terms.) In the process, your original purchase mortgage gets paid off and replaced.

Because closing on a refinance is similar to closing on a purchase mortgage, lender credits work the same way in both scenarios. Deciding whether to accept credits in a refinance comes down to your goals: for example, if you’re refinancing to secure a lower monthly mortgage payment, your long-term savings could be undermined if you agree to lender credits that spike your interest rate.

If you’re debating the pros and cons of credits in a refinance, use an online mortgage comparison calculator to see if the money you’ll save upfront will jeopardize the long-term savings you set out to achieve. Talk to your lender about how credits will impact your final loan amount and total closing costs, and how long it will take for you to “break even” in all three scenarios: paying closing costs yourself compared to rolling those costs into the loan amount compared to accepting lender credits.

A closing cost credit: How credits help cover closing costs

Curious to see credits in action? Here’s an example to consider.

Let’s say you’re buying a home priced at $250,000. You put 20% down, or $40,000, and secure a mortgage for the remaining $210,000.

Your closing costs clock in at $8,400, or 4% of your total loan amount. On top of your down payment, the thought of writing another check is daunting. After all, you still have moving expenses to cover and a few repairs you want to make to your new home.

Lender credits can ease some of the upfront cost burden. In this scenario, a lender credit offer of $3,500 can reduce your closing costs to just under $5,000. While there are remaining closing costs, a credit does keep more cash in your bank account at closing.

You’ll still have to pay a portion of those upfront closing costs, but the credit helps you keep a bit more cash in your pocket in the short-term. If that’s a priority, and you don’t mind a slight spike in your interest rate, taking the credits might be a sensible choice.

What is the maximum lender credit that you can get?

Every lender determines their own caps when it comes to credits, and these caps can also vary by mortgage type.

For example, at Better, we have a $5,000 lender credit limit for conforming loans. For jumbo loans, we removed our cap, which means it’s possible to refinance your jumbo mortgage without paying any closing costs at all.

Points vs. credits: What's the difference?

In a way, points and credits are two sides of the same coin.

Borrowers can use points and credits to manage the cost of their loans—points allow you to pay more at closing to “buy down” the interest rate on your loan, and credits allow you to pay less at closing in exchange for accepting a higher interest rate.

Ideally, points and credits are tools that can help borrowers finalize their mortgage in a way that helps them achieve their financial goals.

Can a lender credit be used for a down payment?

Unfortunately, interested party contributions, or IPCs, are not allowed to be used for home financing or sales. This regulation by Fannie Mae means a borrower cannot use lender credits for a down payment.

Lender credits also cannot be used for financial reserve requirements or minimum borrower contribution requirements.

Are lender credits worth it?

Lender credits can be an advantageous way to reduce closing costs when financing or refinancing a home. But that doesn’t mean they’re the best choice for you.

Before accepting credits, consider whether you can afford the higher interest rate (which will impact your monthly mortgage payment) and if the cash saved in the short-term will justify the potential long-term costs.

If you don’t plan to own your home for more than a few years, rolling those closing costs into your mortgage balance might help you save more money over the life of your loan. If you plan to own your home for the long haul, the increase in interest rate will add up over time and potentially outweigh the upfront savings from lender credits. It all depends on your plans and your financial goals.

See if lender credits are right for you

Lender credits can ease the upfront financial burden of buying your new home or refinancing. But to know if lender credits will help you, you’ll need to see what types of mortgages are available to you.

At Better, you can get pre-approved in as little as 3 minutes.