Are Lender Credits Worth It?
Lender credits can provide a great opportunity for home buyers short on cash. For example, if you’re a first-time home buyer and would prefer to have some emergency cash available, or if you’re starting a savings account for home maintenance costs, using lender credits could help you put the money you’d otherwise spend on closing to good use.
However, it’s important to remember that lender credits aren’t free money. You pay for anything you take out in credits over the course of your loan when the lender increases your interest rate.
Your monthly mortgage payment may only increase by a few dollars each month, but this small increase can add up to thousands of dollars in a short amount of time. Let’s look at an example.
Lender Credits Example
Let’s say you want to buy a home with a $200,000 principal loan balance and a 30-year term at 6%. Your lender tells you that when you close, you’ll need to pay $6,000 in closing costs. You can take on an interest rate of 6.25% if you don’t want to cover your closing costs.
Mortgage Costs With Lender Credits
If you take the lender credit, the only thing you need to pay for is a down payment in exchange for accepting higher interest rates. You may not have this money on hand after calculating your down payment, so you decide to take the lender credits.
Your monthly payment is $1,231 because you took the lender credits. By the time your loan matures and you own your home, you’ll have paid your lender $243,316 in interest.
Mortgage Costs Without Lender Credits
Now, let’s look at what you’d pay if you had covered your own closing costs. You’d pay $6,000 to your lender upfront and get a 6% rate – paying your own closing costs means a lower interest rate. In this example, your monthly payment would be $1,199. That’s $32 less per month than the higher APR.
Over the course of your loan, you pay a total of $231,676 in interest, which is $11,640 less than what you’d pay with lender credits. Even after you subtract the $6,000 you paid in closing costs when you took your loan, this loan is $5,640 less expensive. Even a small increase in your APR makes a big difference in the total amount you end up paying.
Benefits Of Lender Credits
Lender credits can offer some powerful benefits, especially if you’re short on cash. Here are some reasons why using lender credits might make sense.
You Pay Less Upfront To Your Lender
The major benefit of lender credits is that they allow you to close on your mortgage loan without paying thousands in closing costs. The average home buyer pays about 3% – 6% of their loan’s value in closing costs, which can quickly add up to thousands of dollars. The amount paid in closing costs will vary by location and buyer circ*mstance.
You May Be Able To Buy A Home Sooner
Credits can mean the difference between closing now and more months of saving. Depending on the cost of your rent, the additional cost in interest could be partially offset by savings in monthly rent payments.
More Money Can Go To Your Down Payment
When you use lender credits, you can apply the money you would have paid in closing costs toward your down payment. This can be more financially beneficial for you in a couple ways. First, the higher your down payment, the lower your potential interest rate. Additionally, the premiums for private mortgage insurance (PMI) are bucketed based on the size of your down payment. If you can make a slightly higher down payment to get into a lower bucket, you may not have to pay as much for PMI.
You May Be Able To Avoid PMI
If you’re getting a conventional loan, your lender will require you to pay PMI if you don’t have at least 20% to put down on your home. PMI is a type of protection that safeguards your lender if you stop making your loan payments. If your lender credits allow you to put the full 20% down on your home, you can avoid having to pay PMI on your mortgage.
Your Monthly Payment May Only Increase Slightly
Depending on how many credits you take, your monthly payment may only rise by a few dollars. Using the example above, if you’re like most home buyers, paying an extra $32 a month toward your mortgage is much more feasible than coming up with $6,000 or more to close.
You Can Save Money If You Sell Soon After Buying
The main drawback of the higher interest rate that results from using lender credits is that you pay more for your loan as it matures. However, if you plan to sell your home or refinance in a few years, the higher interest rate is less of a concern. You might end up paying just a few hundred dollars more in interest. When you compare this amount to the thousands you may pay when you close on a house, you save money using credits. Just remember that refinancing has closing costs as well.
