The Mysterious Advantage of Lender Credits

Let’s talk about the mysterious advantages of lender credits. What exactly makes them so mysterious? What are they? You know, we don’t really hear much about them.

Lender credits go against the way we’re supposed to think: the lowest rate is the best. Many have heard about paying points. Points is a scenario where you give the lender upfront money – cash – in exchange for a lower overall interest rate. Well, what’s the reverse of that? Think of a lender giving you a little bit of cash upfront in exchange for a slightly higher interest rate.

Lender credits are not for everyone, but sometimes they can be very attractive. For a bondholder, it’s a cash flow game. If they assume you’ll keep that mortgage for seven years, they’re willing to give you a little bit of money upfront to entice you into that higher interest rate. But the cool thing is, you don’t have to keep the loan that long if you don’t want to or if market dynamics allow you to refinance. There’s a good chance you can refinance with better rates in the future, but the risk is, what if rates never drop? And what if you never get to reposition that loan? So that’s the risk.

If you’re buying a house and are short on cash, lender credits are a fantastic option to help absorb closing costs. If you are refinancing a home, lender credits can help you in the same way. Let me explain why this is so good. On a $500,000 loan, let’s say at settlement, the lender gives you a $10,000 check. You then say to the lender, "alright. I’m going to go ahead and pay you $200 a month in exchange for that $10,000." At some point, there is a break-even period where your $200 a month equals that initial $10,000 they gave you.

If you keep the loan longer than that, the lender made out. You would have won on that deal if you exited that loan and refinanced before that break-even period. Another thing is, as a borrower, you get a tax break on that extra $200 you’re paying. So really, in that previous scenario, that $50 per month recapture period could be more like 60 months or 70 months, five or six years. Lender credits can be highly compelling.

You can do the math to see if it’s good for you, and maybe it just gives you that chance to invest in a home a little sooner and start building equity.