In today’s new generation of homeownership, it’s easy to fall into the category of “house rich and pocket poor”, which means having tons of home equity but no cash flow for investments or emergencies. This can happen quickly when you cover all of your closing costs out of pocket. To avoid this, lender credit is a great option for borrowers who are short on cash.
What is Lender Credit?
Lender credits involve a lender agreeing to cover all or some of a borrower’s closing costs in exchange for a higher interest rate. In 2013, the Consumer Finance Protection Bureau (CFPB) made a new lender credit rule to prevent discriminatory rates. When a loan officer gives you a loan with a higher interest rate than the current market interest rate, the bank and the loan officer can no longer keep the monetary difference between the market rate & par rate. So, if they sold you a higher rate, the monetary difference instead goes towards your closing costs. Loan officers and banks then have to decide how much they are willing to give towards closing costs.
How Does Lender Credit Work?
When you go to a bank or a mortgage lender and give them your financial information to get a loan, they will give you a “par interest rate”. This is the lowest rate they can sell you that meets the costs to run their business without losing money. Then, your bank or lender will charge closing costs fees that are usually 2-3% of the purchase price. This is when you can ask your lender for help to pay for closing costs. They will either offer a lender credit or suggest other available options to give you more wiggle room.
How Much Does Lender Credit Cover?
The amount your lender gives you for closing costs depends on your loan program, credit and financial scenario. Not to mention where rates are at that day. Every lender has a different amount they need to make to maintain profitability.
Here’s an example:
-Let’s say your lender gives you an FHA loan with a 2.625% par interest rate based on a 680 credit score and a $500,000 purchase price for a total monthly mortgage payment of $2,893.52.
-You ask your lender for $10,000 to help cover closing costs.
-Your lender offers lender credit to cover $10,000 in closing costs in exchange for a 3.575% interest rate.
-With the 3.575% interest rate, your monthly mortgage payment increases by $165 for a new total of $3,058.60.
In this example, it’s up to you as the borrower to decide whether you want to save $165 on your monthly payment or save $10,000 on closing costs. Let’s break down both saving options to help you decide which is potentially better for your scenario.
-Take the lender credit amount and divide that by the monthly payment difference to determine the breaking point for the term length.
-$10,000 divided by $165 = 60 months or 5 years
-If you plan on keeping the loan for longer than 60 months, lender credit is the more expensive option long term.
-If you plan on keeping the loan for less than 60 months, lender credit is the cheaper option.
Bottom Line
Before you accept a lender credit offer, determine the breaking point if you keep the loan both long term and short term. If you have an FHA loan, you’ll probably refinance to conventional in 2-3 years to remove private mortgage insurance (PMI). If you have a conventional loan, you might keep the loan longer than the breaking point. Overall, the best option depends on your loan scenario and what your lender can offer to help cover closing costs.
