The scenario: You’ve found your dream house and negotiated a price that’s just barely within your budget. Then, you get a copy of the sales contract and to your surprise, the incidental costs associated with buying a house add thousands of dollars to the price. Legal fees, title insurance, inspection costs, transfer taxes, filing fees and myriad other fees all contributed to the cost bump.
These fees add an additional 2-5% of the home purchase price to your responsibility. And you still have other out-of-pocket expenses, such as the down payment, various mortgage fees, moving costs and possible renovations. At this point, you may be thinking that you overextended yourself and should start looking for a lower-priced house. Before jumping to that conclusion, it’s possible that you can get help with those expenses in the form of a lender credit.
What Is a Lender Credit?
A lender credit is money from your mortgage lender to help cover the mortgage-related closing costs associated with the purchase of your house. Your lender may offer you several thousand dollars in credit to cover most (or all) of the those costs. That credit is then applied to your mortgage.
What Is the Cost to You?
You may be asking yourself: What’s the catch? Well, for one, you aren’t receiving free money by accepting a lender credit. Mortgage options with lender credits come at the cost of a higher interest rate.
The interest rate increase can be very small – as low as 0.125% – in exchange for the credit. However, the increase in interest adds up over time. If you have a 30-year mortgage, those extra dollars in interest each month mean you will eventually wind up paying more than if you had paid the closing costs yourself.
Here’s an example of the difference in payment over time, based on two different interest rates offered for the lender credit:
|What You Pay With Lender Credit vs. No Lender Credit|
|Amount paid after 10 years||$143,225||$145,482||$147,600|
|Loan balance after 10 years||$196,959||$197,821||$198,608|
|Amount paid after 20 years||$286,450||$290,964||$295,200|
|Loan balance after 20 years||$117,886||$119,016||$120,059|
|Total payment over 30 years||$429,673||$436,446||$442,746|
When Is a Lender Credit Beneficial?
A lender credit can be beneficial to you in certain situations. Say the down payment and all the other costs of buying a home have left you strapped for cash. A lender credit can give you some breathing room in your budget. Perhaps it’s even what’ll make your purchase viable. Paying $15 extra per month for the length of your mortgage is often more doable than coming up with $5,000 cash at closing.
If you don’t plan on staying in your house for the full mortgage term, or you think you will refinance, getting a mortgage with a lender credit is a great option. The small interest rate increase for the lender credit won’t make very much difference in the short term, and you will be able to receive your mortgage loan with few to no fees.
The Bottom Line
As with any big purchase, it is important to shop around for your mortgage among different lenders. Be sure to compare the lender credits versus the increase in interest rate. You may be able to get a larger credit for a lower rate increase than you think.
Tips for Saving the Cash You Need at Closing
- To avoid getting a lender credit, start saving for closing costs now. The money you saved for the down payment is not the only cash you need to buy your dream home. Try setting aside a small portion of your paycheck in a high interest savings account. Auto-deposit is a great way to do that. That way, you can save and earn even while you sleep.
- This isn’t the quickest way to save, but it may be the most low-effort: Start using a rewards credit card. If you’re a disciplined credit user, you can switch all your expenses to your card to earn free money. Most credit card companies offer signing bonuses that can equal $500 of free cash, as long as you use your card often.
- It can also be helpful to work with a financial advisor ahead of a big purchase to come up with a financial plan and determine what’s realistic for your budget. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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