What is a lender credit on a mortgage? Money the lender contributes toward the borrower's closing costs in exchange for a higher interest rate: the mirror image of paying discount points to buy the rate down.
Every mortgage rate is a menu. Paying points (one point is one percent of the loan) buys a lower rate; accepting a higher rate earns a credit the lender applies to the closing costs. A lender credit of one percent on a $360,000 loan is $3,600 toward the title, appraisal and prepaid items at closing, and it typically costs about a quarter of a percent on the rate, or roughly $55 a month on that loan. A no-closing-cost loan is one where the credit is large enough to cover all of them.
Whether it is worth it is a break-even calculation. At $55 a month, $3,600 of credit is repaid in about 65 months; a borrower who will sell or refinance sooner than that comes out ahead taking the credit, and one who keeps the loan longer comes out ahead paying the costs and taking the lower rate. Buyers short of cash at closing often take the credit for the simple reason that it is the difference between closing and not.
Lender credits appear on the loan estimate and the closing disclosure as a negative number in the closing costs, and they are separate from seller concessions, which are the seller's money. Both reduce the cash to close; only the lender credit changes the rate.
A worked example
A lender offers 6.25 percent with no credit, or 6.5 percent with a $3,600 lender credit on a $360,000 loan. The higher rate costs $58 a month. The credit pays for itself for 62 months; a buyer planning to refinance or sell within five years takes the credit, and one staying ten years pays the costs.
Compare the payment at two rates
Questions people ask
Is a lender credit the same as seller-paid closing costs?
No. A lender credit is the lender's money in exchange for a higher rate; seller-paid costs are a seller concession negotiated in the purchase contract. Both reduce the cash to close.
Is a no-closing-cost mortgage really free?
No. The costs are paid by a higher rate over the life of the loan. It is a good trade for a short hold and an expensive one for a long hold.