What Is a Lender Credit?

Last updated on January 31st, 2019
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 home 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 financial 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?

  • First determine the type of compensation you’re paying the originator
  • Which will be either borrower- or lender-paid
  • Then check your paperwork to see if a lender credit is being applied
  • To cover some or all of your mortgage closing costs

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.

Today's Rates

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

This way they don’t have to charge the borrower directly, something that might turn off the customer, or simply be unaffordable.

So a loan officer or mortgage broker may receive 1.5% of the loan amount from the lender for originating the loan.

On a $500,000 loan, we’re talking $7,500 in commission, not too shabby, right?

However, in doing so, they’re sticking the borrower with a higher mortgage rate.

While the commission isn’t paid directly by the borrower, it is absorbed monthly for the life of the loan via a higher mortgage payment.

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

On top of this, the lender can offer a credit for closing costs, which again, isn’t paid by the borrower out-of-pocket when the loan funds.

Unfortunately, it too will increase the interest rate the homeowner ultimately receives.

The good news is they might not have to pay any settlement costs at closing, helpful if they happen to be cash poor.

This is essentially the tradeoff of a lender credit. It’s not free money. In reality, it’s more of a save today, pay tomorrow situation.

An 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%

Let’s pretend the loan amount is $500,000. The monthly principal and interest payment is as follows:

  • $2,245.22 at 3.5% ($11,500 in closing costs)
  • $2,315.58 at 3.75% ($4,000 in closing costs)
  • $2,387.08 at 4% ($0 in closing costs)

As you can see, by electing to pay nothing now, you’ll pay more each month you hold the mortgage.

So the longer you keep the loan, the more you pay. Over time, you could wind up paying more than you would have had you just paid these costs upfront.

Alternatively, you could shop around until you find the best of both worlds, a low interest rate and limited/no fees.

A Lender Credit Will Raise Your Mortgage Rate

lender credit

  • While a lender credit can be helpful if you’re cash poor
  • By reducing or eliminating all out-of-pocket closing costs
  • It will increase your mortgage interest rate as a result
  • You still pay, just indirectly over the life of the loan as opposed to upfront

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 their work on 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.

If the borrower elects to use a “lender credit” to cover those costs, it may bump the interest rate up another .25% to 4%. But they can refinance for “free.” This is known as a no closing cost loan.

In other words, the lender increases the interest rate twice.  Once to pay out their commission, and a second time to cover closing costs.

While the interest rate is higher, the borrower doesn’t have to worry about paying the lender for taking out the loan, nor do they need to part with any money for things like the appraisal, title insurance, and so on.

Check Your Loan Estimate Form for a Lender Credit

  • Take a good look at your LE form
  • To first determine the total closing costs
  • Then to see if a lender credit is being applied
  • And if so, how much it reduces your out-of-pocket expenses

On the Loan Estimate (LE), 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…

Check the dollar amount of the credit to determine how much it’s doing to offset your loan costs.

You can ask your loan officer or broker what the mortgage rate would look like without the credit in place to compare. Or compare various different credit amounts.

As noted, the clear 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 many 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?

  • Compare paying closing costs out-of-pocket with a lower interest rate
  • Versus paying less upfront but getting saddled with a higher interest rate
  • If you take the time to shop around with different lenders
  • You might be able to get a low interest rate and a lender credit!

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 if you hold onto your mortgage for decades.

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.

For instance, if you take out an adjustable-rate mortgage and doubt you’ll keep it past its first adjustment date, a credit for closing costs might be an obvious winner.

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 temporarily.

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 credit is the better deal, and vice versa. But if you take the time to shop around, you should be able to find a competitive rate with a lender credit!

Read more: What mortgage rate should I expect?

Mortgage Rates Hit 3.93% APR

15 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.

  7. Chris December 30, 2015 at 1:14 pm -

    The question of rate vs credit is one that I’ve been wrestling with here lately….I have more than enough cash on hand to cover my closing costs without a lender credit, but I prefer to keep my cash in an interest bearing account rather than pay out more than I need to. Not to mention, my checking account has a tiered interest levels, so if I drop below a certain number, the interest I earn on my cash drops. Simply stated I do a breakeven analysis (without correcting for inflation) to determine how long it will take me to “spend” the lender credit if I take the higher interest rate. For example, on my upcoming purchase, I have the option of a 3.25% rate and no credits, 3.375% and 2k in credits or 3.5% and 4k in credits. The difference in P&I is roughly $27/mo for every 1/8th of a point. So, if I take the 3.375% rate, it will take me 74 months (or just over 6yrs) before that $2000 will be reached. In this scenario, for my situation, the 3.375% rate makes the most sense. I assume I’ll be in the house for 6yrs, but you just never know, so I’ll take the money up front now. Not to mention, I fully expect my income to be greater in 6yrs than what it is today, so I doubt I will even notice the $27/mo difference.

  8. Colin Robertson December 30, 2015 at 3:30 pm -

    Chris,

    Thoughtful analysis…wish more people took the time to run the numbers based on their OWN situation.

  9. Barb January 30, 2017 at 12:46 pm -

    I have been back and forth with a lender over closing costs on a home loan of approximately 88,000. It is a 203k streamline loan. I feel the costs are excessive at around $7,000.00 I had mentioned the Mortgage credit Points helping out with the closing costs and he had mentioned that #1 it cannot apply to a 203k loan, and #2 the interest rate is tapped out due to my credit and the rate his company offers. I just wanted to know if someone out there can tell me if he is blowing smoke or if these statements are TRUE.
    Please help.
    Thanks!

  10. Colin Robertson February 1, 2017 at 12:32 pm -

    Barb,

    A lender credit will increase your interest rate and could potentially mean you’re capped at X rate in order to qualify, or if that’s the max interest rate they allow for a given program. May want to compare his costs with other lenders to determine if the costs are indeed excessive and you can find a better deal.

  11. Shelia Andrews February 16, 2017 at 8:24 pm -

    My DH and I are closing on a loan 2/24 with BofA. On our first Closing Disclosure (received this am) and our original estimate, the lender credit was $771 on our $265k loan w/3.75% rate. We had requested that they not include Hazard or taxes on the loan as we don’t carry escrow so they redid the Closing Disclosure this afternoon. To my surprise, the lender credit is now $439.90! This is on a 15 year conventional (fixed) loan with 20% down. My DH has a credit score of over 780 and mine is over 740 (but barely).

    We have relationship banking with BofA and I’m very disgruntled about this. It’s only $331.10, but it seems like they have tried to sneak it in because we removed escrow!

    Should I question them about it or is it par for the course when escrow is removed? The loan amount didn’t change.. I guess their ability to “loan” out my escrow account did.

  12. Colin Robertson February 17, 2017 at 10:01 am -

    Sheila,

    Doesn’t hurt to question them to see what changed, it could be that the lender credit just worsened somewhat though the interest rate remained the same, this is assuming you didn’t lock already.

  13. Shelia Andrews February 22, 2017 at 4:16 pm -

    Colin,

    We had already locked in the rate and it’s locked until 03/06/17. Still set to close Friday and still don’t have the final disclosure.

  14. Clara June 25, 2017 at 6:51 pm -

    I am new to this and confused lol can you tell me who your lender is?

  15. Colin Robertson June 26, 2017 at 8:28 am -

    Clara,

    Nearly all lenders offer lender credits, it’s just the way the loan is structured so you pay fewer or no closing costs out of pocket, and instead pay via a slightly higher interest rate on your mortgage each month.

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