Have you heard of the term ‘lender credit’ before? Perhaps you saw it online, and it’s a little confusing as to why it exists. Are you curious about why some lenders offer it and some do not? Or why do some lenders offer it higher at a certain rate while others do not offer any credits at that same rate?
I’m going to explain everything you need to know about lender credits so that you can have a firm grasp of the concept. This will also help you understand how to negotiate for them and recognize when you’re being offered a bad or great deal.
Lender credit is a bit of a loaded subject. I have lender credits on many of my deals because I structure my loans differently. This is why I will let you in on the essential things you need to know about lender credits. To start with, you need to understand how rates work.
Your mortgage interest rate floats around; it changes daily, especially if dealing with a conventional or an FHA loan. Even on most jumbo loans, your rate will fluctuate daily, and it’s rarely going to be at what we call Par. Par is where you pay nothing for the interest rate and you get nothing for the interest rate.
When you get a loan on a home or when you’re buying or refinancing, there are always closing costs. Sometimes, they’re very high, especially on a purchase. They could be as much as $20,000 if it’s a very expensive home, and sometimes on a refinance, they might be only a couple grand. Closing costs will always be there, so if you hear someone saying it’s a loan with no closing costs, know that they’re just paying it in lender credits. You’re paying for the closing costs in another way, and usually, when you get lender credits, there’s a slightly higher rate.
When we price loans as loan brokers, we go to different banks, saying, “this person has an 800th credit score, they’re coming in on a purchase with 20% down, and they have plenty of money and income to qualify; what do we get? We put this in our little calculators and we shop at that. We say, “okay, we’re going to go with loan depot or Finance America or NMSI or rocket mortgage or whoever we’re going with at the time. We’re going to ask what the current rate is. They might say something like 3.75% with a lender credit of $200. However, it’s usually $212.34 or with a lender credit of $3250.
A discount point is what you pay for the loan. Lender credits are where you get a refund back from the bank, while a discount point is when you’re paying to get it. So we get a rate sheet and we plug in all the numbers. This rate sheet will show us everything from about 2.875 to 4½. Depending on the day’s rates, it doesn’t go over or under a certain amount. No one wants to give you a 6% loan if the average is 4 or 3½. Also, no one wants to provide you with a 1½ because it doesn’t make sense. Usually, they’ll give you a spread, but it’ll be a nice big spread with several interest rates. Every loan broker out there will look for what’s close to par; that’s what’s close to zero: zero credits and zero discount points.
However, it’s rarely at par unless you’re at certain banks who like to offer par rates, where there are no discount points and no lender credits. If you have discount points, they’re really not a true point. A point is equivalent to a percent of a loan. It’s rarely a full percent. Usually, discount points are several fractions of a percent, so you might have a rate close to par; maybe it’s only giving you like $100 in lender credits or something like that. I’ve often seen that; however, the next rate down costs you an additional $2152 or something random like that.
To buy the rate down from 3½ down to 3.375, it might cost you another $2,000. This depends on what kind of transaction that is. If it’s a purchase transaction, this means you will have to come in with more money; so instead of those closing costs being about $10,000, you have to tack on another $2152, so now your total is going to be a little over $1200 in closing costs, which is similar to a refinance.
The difference in a refinance is that you can borrow more money typically to pay that discount point. If you’re borrowing $400,000 on your loan and the discount point is $2,000, you can up your loan amount to $402,000 to buy the rate down. You’re essentially just paying for that $2,000 over 30 years, but at a lower interest rate. Hence, it often makes sense to buy that rate down.
If you’re doing a cash-out refinance, let’s say you’ve lived in a house for a while, you have equity in it; perhaps, you bought it at $400,000, and you’ve lived in it for ten years. Now, it’s worth $800,000, and you’re taking cash out, so you’re getting a loan for $600,000. You’re getting $200, 000 cash out of the property because it’s now worth $800,000. This means that you can get a loan for $200,000 more and you’re refinancing at the same time. Obviously, you want to get discount points, so they’ll just take some of that $200,000 they’re giving you if you’ll buy that rate down. Hence, instead of getting $200,000 back, they’ll give you a $198,000 back for that $2,000 buy down on the rate.
There are ways to do the math on how to figure out whether buying discount points makes sense or not. There’s a straightforward formula and I’ve explained it in another video here. However, there is a way to figure out how long it takes you to break even on it and this is not so complicated.
Lender credits are again the exact opposite of discount points. So, instead of giving money to the bank, you’re getting money from the bank. Typically, lender credits are used to pay closing costs because that’s all they can pay for. Lender credits are never given as cash, so if you use all your lender credits on closing costs, let’s say you’re doing a refinance and your closing costs are pretty minimal, perhaps, it’s for only $2,000, and your lender credits are $3,000. You don’t get a thousand dollars in cash. What happens is that you get a principal reduction. So, if your loan was for $400,000 and they paid all your closing costs and you have $1,000 left of that lender credit, now instead of owing that $400 000, you’re going to owe $399,000. The actual principal amount on your loan gets reduced. This is how lender credits work for closing costs.
Mortgage Origination Fee / Broker Fee
There are two ways mortgage brokers get paid: either by the bank (lender-paid) or by you (borrower-paid). We’ve not been allowed to do both since 2008. It’s called Double Dipping and it’s not allowed anymore. It used to be allowed and that’s part of the reason why the mortgage bubble happened. Just so you know, I wasn’t a mortgage broker in 2008.
One thing to look out for is typically a mortgage origination fee or a broker fee on your loan estimate and not a processing fee. It’s in the same section; you want to see either an origination fee or a broker fee. If you see one of these two, it means the bank is not paying the broker or the loan officer, and that you are. Even though this might sound like a negative thing, it’s pretty positive for you. As you pay them, the rate goes down, so if the bank doesn’t have to shell out 1% to 2% of the loan amount to pay the broker for bringing you over to that bank, they’re going to give you a lot lower interest rate. Usually, a much lower interest rate comes with lender credits.
Often, when people come to me and say that they have 3½% with no discount points, I ask if there are any lender credits at 3½, and they say no. Then, I’ll tell them that if they want 3½, I could probably get them $3,000 in lender credits. How do I do this? It’s pretty simple. I typically charge them about $3,000 for the loan, but I’ll get the $5,000 or $6,000 in lender credits. Essentially, this pays both my fee and some closing costs. This might get confusing because, technically, lender credits cannot be used to pay the broker’s fee. However, I tend to look at the net positive effect on how much they’re paying for the loan, so even if it goes towards a principal reduction or another aspect of the loan, it still ends up positive for them.
If you do not see a loan origination fee or a mortgage brokerage fee, know there might be some wiggle room. You might be able to bargain with the broker or lender by offering to pay for the loan or the broker fee to see if you can get a better discount from the bank. The answer is always going to be yes. You can get a better discount from the bank this way because they’re not paying you anymore; instead, they will pass those savings on to you.
Buying the Rate Down
Always ask to buy the rate down. Asking is key. Now, you don’t always have to buy the rate down. In fact, I often don’t recommend buying the rate down. However, I recommend asking what it costs to buy the rate down. This is asking how much to buy the rate down and how much lender credits if you go up on the rate.
Eight of a Percent
We usually think in an eighth of a percent as mortgage brokers, so it’s not just 3, 3¼, 3½, 3¾ and 4. We think in 1/8 step increments, which is the most common, so it’s 3%, 3.125%, 3.25%, 3.375%, 3.5%, 3.625%, 3.75%, 3.825%, 4%. We think in terms of eighth increments because that’s typically what’s on a rate sheet. Some banks do kind of funky 3.31 and so on, but an eighth of a percent is the classic stepping ladder kind of situation. So when you’re asking about rates, ask your loan officer how much it would cost to buy your rate down by an eighth of a percent. It’s always worth knowing.
Now, if an eighth of a percent down costs $4,000 or $5,000, which probably doesn’t make sense for a typical conventional loan, as that’s under a few million. Conversely, if they’re offering you $5,000 0r $6,000 in lender credits to go up an eighth of a percent, sometimes that’s a steal. So you want to know what your options are, and it doesn’t hurt to ask. Make sure you ask how much it costs to buy it down an eighth or how much lender credit you can get if you go up an eighth.
Paying Your Closing Costs with Lender Credits
Suppose you’re tight on cash, and you’re buying a house for the first time or even the second time, and you don’t have the money for closing costs. In that case, one thing you can do, which I often recommend, is to get a slightly higher rate or even a massively higher rate but get a lot of lender credits, with which you can pay all of your closing costs and lender credits.
This is especially popular with FHA loans because their rates are going to be pretty low. It might be a full percent lower than a conventional loan is at the time. So if someone’s paying 4%, you might be paying a 3% loan on the FHA. Now, you might say that you are only planning on keeping the loan for like three years and that you have fifteen thousand dollars in closing costs. Now you want to know how much lender credit you can get if you go to like 3,625. Often, you’ll get $12,000 to $13,000 in lender credit, which will pay the closing costs that you would typically have to pay in cash.
Suppose you’re only going to stay in that house for a few years, or you’re going to house hack by having other people live there and pay your mortgage, or you’re planning on refinancing in a few years because you’re going to do some remodeling. In that case, lender credit will be a fantastic tool to save money on closing costs.
Ask for two different loan estimates. It’s okay to ask for two or three different loan estimates. However, don’t ask for six or twelve. I’ve had people who asked for like nine different loan estimates. Usually, I’d give them the high one and the low and ask if there is something they want to see in-between. It’s annoying and it’s a lot of work. Usually, I find that people who ask for ten loan estimates rarely close on a loan anyway. It’s not a problem if you ask for two or three. You can say, “Hey, I want to see you know the loan cost with me paying versus lender-paid and I also want to see one where I buy the rate down another eighth of a percent”.
I’d be happy if someone came to me and asked to be shown a loan estimate of a lender-paid vs borrower-paid, and a borrowed paid buying the rate down an eighth of a percent. I’d be so impressed that I would do it instantly. This is my kind of buyer because they know what they are talking about. They are serious about the loan process. I don’t have to educate them, and I’m going to send them three thorough loan estimates, and if they need help reading anything, I’ll be there for them. They will probably decide quickly because they know what to ask for.
That’s music to a loan broker’s ears unless, of course, they’re price gouging. You don’t want to work with those lenders anyway. Though for me, it’s a great situation. Many of my clients are realtors buying houses for themselves because they know I give them a great rate and I don’t negotiate. It just looks like I’m giving them bottom of the barrel pricing, and I’m giving them a quick loan because they already know about loans, so there’s nothing to talk about. It’s even better for all of us; they don’t have to sit there and be sold to, I also don’t have to sell. I give them a low rate, and they know a good deal when they see one and we’re good to go.
If you continue to educate yourself by watching my videos about the mortgage process, you can be in that club too, where you know what you want. That’s how people who buy multiple properties in their lifetime act when it comes to real estate.
Now that you know everything you need to know about lender credits and most of what you need to know about discount points, I recommend watching my video that talks about reading a loan estimate from start to finish. This will ensure that you see those lender credits or discount points in writing on the document that matters. I broke down the entire loan estimate line-by-line, as it is probably the most crucial document you’ll see in your loan process.