What Is a Lender Credit?

February 15, 2012 6 Comments »
What Is a Lender Credit?

Mortgage Q&A: “What is a lender credit?”

Back before the mortgage crisis reared its ugly head, it was quite common for loan officers and mortgage brokers to get paid twice for originating a single loan.

They could charge the borrower directly, via out-of-pocket mortgage points, while also receiving compensation from the issuing mortgage lender, via yield spread premium.

Clearly this didn’t sit well with regulators, so in light of this perceived injustice to borrowers, changes were made that essentially limited a loan originator to getting just one form of compensation.

Borrower-Paid vs. Lender-Paid Compensation

Nowadays, loan originators must choose either borrower or lender compensation (it cannot be split), with many opting for lender compensation as a means to keep a borrower’s out-of-pocket costs low.

With lender-paid compensation, the lender essentially provides a loan originator with “X” percent of the loan amount as commission.

So a mortgage broker may receive 2% of the loan amount from the lender for handling the loan. However, in doing so, they are sticking the borrower with a higher mortgage rate. This is the tradeoff.

In other words, a mortgage with lender-paid compensation will come with a higher-than-market interest rate, all else being equal.

Quick example of a lender credit:

Loan type: 30-year fixed
Par rate: 3.5%
Rate with lender-paid compensation: 3.75%
Rate with lender-paid compensation and lender credit: 4%

As you can see, in the scenario above the borrower actually qualifies for a par mortgage rate of 3.5%. However, they are offered a rate of 4%, which allows the loan originator to get paid for handling the loan, and provides the borrower with a credit toward their closing costs.

The loan originator’s lender-paid compensation may have pushed the interest rate up to 3.75%, but there are still closing costs to consider. They may bump the interest rate further to 4%, using a “lender credit” to cover those costs so the borrower can refinance for “free.” This is known as a no closing cost loan.

In other words, the loan originator increases the interest rate twice.  Once for their commission, and a second time to cover closing costs.

On the Good Faith Estimate, you should see a line detailing the lender credit that says, “this credit reduces your settlement charges.” It’s a shame it doesn’t also say that it “increases your rate.”  But what can you do…

The obvious benefit is avoiding out-of-pocket expenses, which is important if a borrower doesn’t have a lot of extra cash on hand, or simply doesn’t want to spend it on refinancing their mortgage.

It also makes sense if the interest rate is pretty similar to one where the borrower must pay both the closing costs and commission.

For instance, there may be a situation where the mortgage rate is 3.5% with the borrower paying all the closing costs and commission, as opposed to 3.75% with all fees paid thanks to the borrower receiving a lender credit.

That’s a relatively small difference in rate, and the upfront closing costs for taking on the slightly lower rate likely wouldn’t be recouped for years.

Of course, it should be noted that the larger the loan amount, the larger the credit, and vice versa, seeing that it’s represented as a percentage of the loan amount.

So those with small loans might find that a credit doesn’t go very far, or that it takes quite a large credit to offset closing costs.  Meanwhile, someone with a large loan might be able to eliminate all closing costs with a relatively small credit (percentage-wise).

In the case of borrower-paid compensation, the borrower pays the loan originator’s commission instead of the lender.  The benefit here is that the borrower can secure the lowest possible interest rate, but it means they generally pay out-of-pocket to obtain it.

They can still offset some (or all) of their closing costs with a lender credit, but that too will come with a higher interest rate.  However, the credit can’t be used to cover loan originator compensation.

If you go with borrower-paid compensation and don’t want to pay for it out-of-pocket, you can use seller contributions to cover their commission (since it’s your money) and a lender credit for other closing costs.

[Are mortgage rates negotiable?]

Which Is the Better Deal?

There are clearly a lot of possibilities here, so take the time to see if borrower-paid compensation will save you some money over lender-paid compensation, with various credits factored in.

Generally, if you plan to stay in the home (and with the mortgage) for a long period of time, it’s okay to pay for your closing costs out-of-pocket and even pay for a lower rate via discount points. You could save a ton in interest long-term by going with a lower rate.

But if you plan to move or refinance in a relatively short period of time, a loan with a lender credit may be the best deal.

You won’t have to pay much (if anything) for taking out the loan, and you’ll only be stuck with a slightly higher interest rate and corresponding mortgage payment.

As a rule of thumb, those looking to aggressively pay down their mortgage will not want to use a lender credit, while those who want to keep more cash on hand should consider one.

There will be cases when a loan with the lender credit is the better deal, and vice versa. So shop around! You should be able to find a competitive rate with a lender credit.

Read more: What mortgage rate should I expect?

Compare Today’s Mortgage Rates

6 Comments

  1. home benefit July 31, 2012 at 9:45 pm -

    When push comes to shove, the borrower is looking at an interest rate that will determine their monthly Principal and Interest payment based on a loan amount along with closing costs that they need to pay (or not pay in cases of a credit) for services provided to originate the loan. If a direct lender has interest rates above and beyond what a broker is able to secure in wholesale market plus broker commission , then the broker has earned his due in securing a better deal for the borrower. Brokers do this by letting wholesale mortgage firms compete for business at hand. Wholesale lenders have been extraordinarily aggressive to provide rates to Brokers so they originate loans for them at the best terms they can offer. Brokers earn their keep by shutting out costs and expenses that retail lenders need to recoup for having to subscribe to new-founded restrictions on retail loan branches. Let the best deal win for the consumer!

  2. Brenda October 16, 2012 at 8:28 pm -

    I have a unique situation.
    I currently am in a conventional 30 year fixed with 4.625%, the original loan is 212,000. We now owe 165,000 with 27 years left on the loan.

    I have been offered 3.25% interest rate with closing costs of 4,578, and also my full year of escrow that I will be reimbursed after the loan is paid off. that I pay out of pocket for 165,000. 30 Year fixed.

    I also have been offered 3.25% interest rate with closing costs of 1,200, but also with the lender willing to pay 4,186 dollars as a Lender Credit. So all I need to bring the year of escrow to closing.

    I have been haggling with a few lenders and it’s nice to see they are throwing their weight around trying to get me the best deal possible for my family.

    Going to move forward with the company offering the lending credit – which is beneficial to my family, without raising the interest rate.
    We will be saving over 371 dollars per month.

    Our plan is to pay our mortgage the same way. We already pay extra 727 per month on principal.

    After the refinance we will pay off our loan in 8.5 years and be debt free.
    Loving this!

  3. Ray July 17, 2013 at 10:00 am -

    I just received a lender credit that pays for all my closing costs (including third-party fee) and my interest rate is lower than most competitors. Shop around folks. And ask about credits. You might be able to get the best of both worlds.

  4. Roselle July 18, 2013 at 9:52 pm -

    I know my mortgage rate might be higher, but I elected to receive a lender credit to cover all my closing costs on a new purchase. The costs were quite substantial (nearly $10k), and because I won’t have to pay them out of pocket, I’ll have more money set aside for renovations, mortgage payments, and whatever else comes my way as a new homeowner. And my rate is still cheap!

  5. Sarah November 1, 2013 at 8:09 pm -

    Does it make sense to accept a lender credit on a fixed-rate mortgage? Shouldn’t you be trying to secure the lowest rate possible if you’re going to keep it for a while?

  6. Colin Robertson November 3, 2013 at 12:25 pm -

    I understand your logic…why go with a fixed mortgage if you don’t get the lowest rate possible, seeing that a borrower with a fixed mortgage ostensibly plans to hold it long term. But some homeowners still want/need to keep out-of-pocket costs low while avoiding the uncertainty of an ARM. So it can make perfect sense.

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