Understanding Lender Credits and Discount Points

When securing a mortgage, borrowers must also consider closing costs which can range from 2% to 5% of the loan amount. To help ease this aspect of financing a home, banks and lenders may offer lender credit, which covers some or all of the closing costs in exchange for a slightly higher interest rate. Conversely, borrowers who want a lower interest rate can pay discount points, an upfront fee that reduces the loan's interest rate.

Lender Credit

Lender credit allow borrowers to pay a significant % or all of their closing costs by accepting a higher interest rate. This means the lender will cover some or all closing costs, but the borrower pays more over time due to the higher rate.

How Lender Credit Works

• A lender offers a 6.5% rate with 0 lender credit, requiring the borrower to pay $3,500 in lender closing costs.
• Alternatively, the lender offers a 6.75% interest rate with a $3,550 Lender Credit, covering all the lender closing costs.
• The borrower avoids upfront costs but pays more in interest over time.

Who Benefits from Lender Credits?

• Borrowers with limited cash for closing costs.
• Short-term homeowners (since they won’t pay the higher interest for long)
• Those prioritizing lower upfront expenses over long-term savings.
• Short-term homeowners (since they won’t pay the higher interest for long).
• Those prioritizing lower upfront expenses over long-term savings.

Discount Point(s)

Discount points work the opposite way. Instead of increasing the rate, borrowers pay an upfront fee to buy down the rate, reducing monthly payments and overall interest costs.

How Discount Points work

• One discount point costs 1% of the loan amount and typically lowers the rate by roughly 0.25% - .375%
• A borrower with a $300,000 loan and a 6.50% interest rate can pay $5,000 (one point) to reduce the rate to 6.25%.
• Over several years, this can save thousands in interest payments.

Who Benefits from Discount Points?

• Long-term homeowners (planning to stay in the home for many years)
• Borrowers who can afford higher upfront costs.
• People looking to lower their total mortgage interest over time.

Lender Credit vs. Discount Points: Which Is Better?

Choosing between lender credits and discount points depends on how long you plan to stay in the home and your financial position/priorities. If saving upfront is key, lender credits help reduce closing costs. If long-term savings matter more, paying for a lower rate with discount points makes sense.

Before deciding, it’s best to compare multiple rate options and calculate the breakeven point to determine which choice aligns with your goals.

Here’s an example comparing lender credits and discount points for a $500,000 mortgage on a 30- year fixed loan:

Scenario 1: Standard Rate (No Credits or Points)

• Loan Amount: $500,000
• Interest Rate: 6.50%
• Monthly Principal & Interest: $3,160
• Lender Closing Cost Credit: $0

Scenario 2: Lender Credit (Higher Interest Rate, No Upfront Closing Costs)

• Loan Amount: $500,000
• Interest Rate: 6.75% (.25% higher in exchange for lender credit)
• Monthly Payment: $3,243
• Lender Closing Cost Credit: $3,750
• Extra interest over 5 Years: $4,960
• Best option for: Buyers who lack cash for closing costs and plan to sell or refinance in less than 5 years.

Scenario 3: Discount Points (Lower Rate, Higher Upfront Cost)

• Loan Amount: $500,000
• Interest Rate: 6.75% (Borrower pays 1 point = $5,000 closing costs)
• Monthly Payment: $3,079
• Discount Point(s): $5,000
• Total Interest Savings Over 5 Years: $4,880
• Break-even Point: ~5 years (after this, savings outweigh upfront cost)
• Best for:Buyers planning to stay 5+ years who want lower long-term costs.

Takeaway

• If you plan to sell or refinance in 5 years or less: Take the lender credit (with a slightly higher rate, reduced closing costs).
• If you plan to stay 10+ years: Consider paying discount points (lower rate, long-term savings).
• If unsure: Contact US to evaluate current market rates and opportunities.