No-closing-cost mortgages: how lender credits really work

How lender credits work

The CFPB describes lender credits and points as two sides of the same trade-off. Points lower your interest rate in exchange for paying more at closing. Lender credits lower your closing costs in exchange for a higher interest rate.

Lenders typically quote a range of rates for the same loan. Lower rates come with points, and higher rates come with credits. A no-closing-cost loan is simply a rate high enough that the credit covers most or all of your closing costs.

The CFPB's tip is worth repeating. If you do not know how long you will stay in the home or when you might refinance, and you have enough cash for closing and savings, you might not want to pay points to lower your rate, or take a higher rate to receive credits. If you are unsure, ask a loan officer to show you options.

Where to find the credit

On the Loan Estimate, lender credits appear on page 2 in the calculation of cash to close. Comparing two Loan Estimates from the same lender, one with a credit and one without, shows exactly what the higher rate buys you. Check that the same credit carries through to your Closing Disclosure.

What the credit can cover

A lender credit offsets closing costs. It generally does not pay for the down payment, and loan programs limit what happens if a credit is larger than your costs. Fannie Mae's reserve rules, for example, say lender contributions do not count as reserves.

Not every cost is the same. Some closing costs are one-time fees, while prepaid items such as homeowners insurance and the initial escrow deposit are amounts you would pay anyway. Ask your lender which costs the credit will cover.

The break-even calculation

The trade-off comes down to two numbers: the credit you receive now and the extra you pay each month because of the higher rate. Divide the credit by the monthly difference to find roughly how many months it takes for the extra payments to equal the credit.

• If you sell or refinance before that point, the credit saved you money.
• If you keep the loan longer, the higher rate costs more than the credit was worth.

This is a simplified view. It ignores what you could earn on the cash you keep, tax effects and the slightly different paydown of the loan balance. It is still a good guide.

Other ways to lower cash at closing

A lender credit is one option. Compare it with:

• Seller concessions, where the seller pays part of your closing costs. Loan programs cap these.
• Assistance programs, which sometimes cover closing costs for eligible buyers.
• Shopping for services the Loan Estimate shows you can shop for, such as title and settlement services in many areas.
• Choosing a closing date that reduces prepaid interest, which you pay from closing to the end of the month.

Questions to ask your lender

• What rate and credit options do you offer for my loan, from points to the maximum credit?
• Which of my closing costs will the credit cover?
• If the credit is more than my costs, what happens to the extra?
• How does the credit appear on the Loan Estimate and Closing Disclosure?

The bottom line

A no-closing-cost mortgage usually means a lender credit paid for with a higher rate. It can make sense if cash at closing is tight or you expect to sell or refinance within a few years. Divide the credit by the extra monthly payment to find your break-even, and compare same-day Loan Estimates before choosing.