Where Does the Lender Credit Come From?

Lender CreditOn your mortgage estimate, you might see a credit for several thousand dollars to be used toward closing costs. I’ve been asked, “Is this legit? Is this real? Where does that money come from?”

To answer, when a lender gives you an interest rate higher than par rate, there is an extra profit, or extra cash that can be given to you as a credit. Par rate is the base rate that does not yield extra profit to the lender nor require money (charged in percentage points) to buy it down. Par rate changes daily.

A perfect example is a set of two mortgage estimates I reviewed yesterday for one of my coaching clients. The lender had given him these choices for a 30-year fixed rate, 10 percent down payment, top tier credit:

Choice #1

3.375% with a cost of 0.4 percentage points. For his loan amount of $405,000, that was a cost of $1,701.

Choice #2

3.75% with a lender credit of $8,059. That would give him over eight grand to pay his closing costs. The lender had that much money to give, because 3.75% was over the par rate of 3.4% (on that day).

Which is Better?

The difference between these two loan offers is $9,760. (A cost of $1,701 versus a credit of $8,059.) Talk about going from one extreme to another!

First, I do not recommend paying $1,701 to get an interest rate one eighth of one percent (0.125%) lower than par rate. For his loan amount, it would take five years just to break even on that cost. That is too long, in my opinion. Also, he happened to be tight on money for closing costs after he made the 10 percent down payment, so why would he spend so much extra to buy down his rate? Better to keep that money in an emergency account.

I recommended asking for 3.5% with zero cost.  This is because 3.5% is the closest rate to par rate for the day (yesterday). Depending on the day he locks in, there may or may not be a small credit, depending on exact par rate.

However, if he found that his dream house — the one he and his wife fell totally in love with and absolutely had to have — took all of his cash for the down payment, leaving him without enough left for closing costs, then taking the higher interest rate (and higher monthly payment) so that he’d get the big lender credit to cover closing costs was a viable option.

Personally, I would rather see him take 3.5% par rate on a more affordable house with a lower monthly payment.

But for a person with a low debt ratio and high income, the higher interest rate is not a turn-off, and the lender credit is an advantage one might choose to take.

By the way, if you read Mortgage Rip-Offs and Money Savers, you know this lender credit is the Yield Spread Premium (YSP). Per new lending laws, if a lender is charging an origination fee (including processing fee, underwriting fee, administration fee, application fee), then any YSP they receive must be given to the borrower as a credit. However, if the lender is a bank or a direct lender using their own money to fund the loan, they do not have to reveal or credit you any extra profit they make. And don’t bother asking, because they will never tell you what their overage/profit is. Most will deny it altogether, because as a bank or direct lender, they don’t call it YSP; they call it SRP (Service Release Premium).

If you have any questions about lender credit, please feel free to ask. And once again, thank you for stopping by to read my blog.

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