When comparing mortgages between lenders, you’re likely to come across the terms “lender credits” and “discount points.” These refer to the options some mortgage lenders offer to improve the client’s interest rate or closing costs through credits and discounts.
Usually, there’s a trade-off between interest rates and closing costs. Depending on your budget, how long you plan to own your home, and what is important to you, credits and discount points can offer you more favorable results and get you closer to your ideal home budget, allowing you to better customize your mortgage experience.
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Lender Credits vs. Mortgage Discount Points: What’s the Difference?
Typically, lender credits are a kickback that your lender offers to you when you choose to take a higher interest rate. This can help you cut back on closing costs, which can be a considerable expense. On the other hand, discount points are used to lower your overall interest rate on your mortgage. However, you must pay an upfront fee to your lender to earn discount points. Essentially, the differences are to pay more upfront to save money each month or save money upfront and pay a bit more each month.
How Lender Credits Work
To reiterate, you can apply lender credits toward your closing costs in exchange for taking a slightly higher interest rate. The lenders you work with have an interest in doing this because you may end up paying slightly more over the life of your loan, and some lenders may have promotions or offers on lender credits. However, closing costs can be significant, so if you’re looking to reduce some costs on the front end of your home purchase, this can certainly help.
Closing costs are the administrative costs associated with finalizing your home purchase. So, in addition to your down payment, this can include costs associated with home inspections, appraisals, title searches, and more. These are costs you pay to your lender since they usually organize and facilitate many of these functions, including the appraisal.
Many people consider the down payment when saving for their home purchase, only to be surprised by the other costs. Accepting a higher interest rate can help you curb some of the unexpected costs now and make the whole process more budget-friendly. In addition, if you’re planning on refinancing or selling your home within a few years, paying a slightly higher interest rate during that term in exchange for applying lender credits on closing costs could be a cost effective option.
What Can You Use Lender Credits On?
How you use your lender credits depends on what arrangement you make with your mortgage lender. In some scenarios, the lender may cover closing costs; however, this can come at a steep rate increase. In others, the lender may choose to cover their fees and third-party fees like the appraisal, but not fees like taxes and insurance. Other lenders may cover their own fees and nothing more. Connecting with your potential lenders to inquire about how to apply for lender credits can help you find a lender that can help you meet your budget.
In some cases, you may even be able to negotiate credits in a way that reduces your closing costs by a more specific amount of your choosing. This can give you and the lender more wiggle room to find something that works. That way, you can reduce some closing costs without raising your interest rate (and therefore your monthly payment) too high. This may accommodate your immediate and future budget better.
Benefits of Lender Credits: When Should You Use Them?
The primary benefit of lender credits is to reduce your upfront costs. For example, you may find out that you’re closing on a house, and the costs are much more than you have anticipated. Your closing costs are typically independent of your loan, so you pay them out of pocket.
Working with your lender to reduce some of these costs can help you to get the house you want on time without retracting your offer or backing out. The downside, however, is that the more money you take off of your closing costs, the higher your interest rate will become. For example, if you are trying to shave thousands of dollars off of your closing costs, you may inadvertently increase your monthly payments by a substantial amount because of the increased interest rates.
This also increases your overall interest costs. To negate this, you may choose to refinance your home in a few years, which could give you more favorable interest rates. Keep in mind, however, that there are still closing costs associated with refinancing. To truly refinance your home for a better rate, you may still need to save money for future closing costs.
In a low-interest-rate environment, you may have more wiggle room to increase your rate and still feel comfortable with your monthly payment. If this is the case, you could end up saving a large amount of money upfront. You can even apply this to your down payment to reduce your overall loan.
As you plan out the possibility of using lender credits, be sure to keep your monthly budget in mind as well as how long you plan to own your home. For example, if you only plan to own your home for a short time before reselling it, taking a lender credit for a higher interest rate could work in your favor. Consider how much you’re able to pay at a maximum so that as you work out what’s possible for you, you don’t overexert your finances.
How Mortgage Discount Points Work
On the other hand, discount points are points that you can apply to your interest rate to lower it. You get these points by paying for them. This means if closing costs aren’t a major concern for you, you can focus more of your resources towards lowering your rate.
This helps to lower your monthly mortgage payment, which could free up more of your budget. This also means that you would reduce your overall interest cost on the life of your loan. Discount points function by allowing you to pay more now to save money in the long term on your loan.
Discount points are calculated in relation to your base loan amount. Every point represents 1% of your loan. This means that on a loan of $100,000, you can get 1 discount point, or 1%, for $1,000. So if you wanted to reduce your interest rate by 2%, that would cost an additional $2,000 at closing. One of the benefits of this system is that you have a lot of flexibility, and you can even purchase a fraction of a point if that works better for you.
Note that the points don’t work across lenders, making it more difficult to compare loans across multiple loan types and lenders. For this reason, a “0 point loan” is your initial loan offer, which represents the initial interest rate offered to you. You may want to compare loans without points first, then consider buying discount points to lower your chosen loan from there. That way, you can get a more accurate comparison overall.
What Can You Use Discount Points On?
By the time you acquire your points, you have already chosen your lender and your loan. Since you purchase discount points upfront at the time of closing, there are limits to how they can be used. The cost of your points is included in your closing costs, which means that you cannot use them to reduce your closing costs. This means you cannot use points to reduce your down payment, appraisal, and other costs.
If you wish to use points when refinancing your home, new points must be purchased with your new closing period. You cannot save your initial discount points and use them for a later transaction, as refinancing means you’re working with a new contract, terms, and face amount on the loan.
Benefits of Discount Points: When Should You Use Them?
One of the primary benefits of buying discount points is the reduction of your interest rate. If you’re buying a home in a particularly high interest rate environment, you can benefit from reducing your interest rate. This is especially true if you see yourself living in this home for a long time without refinancing, which can incur additional closing costs down the road.
If you have the money set aside to increase your closing costs, it’s worth looking into discount points. It’s worth noting, however, that if you’re interested in the lowest rate possible, it’s a good idea to thoroughly vet your loan options. Starting with the lowest zero-point loan is going to create a less expensive path to your ideal interest rate.
It’s also a good idea to check with your lender or potential lenders to see what their fine print says about discount points. In some instances, lenders may assign a slightly higher or lower value to a single point than other lenders. You can find more information about discount points in your loan estimate or by connecting with your lender.
By securing a lower interest rate, you can save money on interest over time, which is a big driving factor for many people. Doing this also reduces your monthly payment. It’s important that you have the savings set aside to pay for the desired discount points, and because you can buy points on a fractional basis, you have the option to make even a small reduction on your interest rate to save some money each month.
Things To Consider With Lender Credits and Discount Points
If you’re trying to determine whether you can buy discount points or seek lender credits, look to your budget first. Assess how much money you have set aside to cover closing costs, and also consider your monthly budget. In some cases, you may not have a lot of flexibility in either direction.
In this case, you might benefit from finding the lowest available interest rate to begin. Otherwise, you can determine where you wish to make some compromises on your home costs and whether you’d like to lower your rate or your closing costs.
A good place to start is shopping your options with lenders. This way, you can compare the terms based on the initial interest rate and potential closing costs first. Then, find a starting place that you’re comfortable with. From there, you may even have some negotiating power.
If you have a good credit score (about 670 or higher) and a low debt-to-income ratio, you typically will have more bargaining power. Paying off some debts can accomplish both of these things and increase your chances of getting more favorable options from lenders.