Most home buyers spend hours — if not, days — comparing numbers. From asking price to real estate taxes to homeowners insurance, the home-buying process requires crunching a lot of numbers to determine the true costs associated with owning a home.
You would think the numbers game would be over once an offer on a home is accepted, but it’s not. When a buyer sits down at the table to close on a home, there is a whole new series of numbers to be considered. They are called closing costs, and they often involve a variety of “credits” that can be confusing to the uninitiated.
“When you are shopping for a mortgage provider, you will likely hear about different types of lender-provided credits that can lower the amount you have to bring to the closing table,” explains Yatin Karnik, Founder and CEO of Confer Inc. “However, some of these credits come with a cost. If you are shopping for a home, it is helpful to be familiar with the most common types of credits offered by lenders, as well as the benefits and pitfalls of each.”
Confer Inc. is an innovative mortgage platform powered by continuous machine learning and artificial intelligence. By making it easier for borrowers to compare the various costs associated with mortgages, the Confer app equips home buyers to discover the best mortgage options and, ultimately, save money.
Closing costs, which typically range between 2 percent and 5 percent of the mortgage amount, can come as a shock to new home buyers. As a result, any offers to reduce those costs can be welcomed. However, as Yatin warns, there may be a downside to the credit. Here are some things to know before saying yes.
Lender credits: higher interest rate, less to close
Lender credits, which are sometimes also known as Credit for Interest Rate Chosen, are granted by the lender when the buyer agrees to a higher interest rate for the mortgage loan. This credit is a percentage of the loan amount and is applied to the costs the borrower must pay at closing.
“Lender credits can be enticing as they lower closing costs, which means the home buyer pays less at the time of closing,” Yatin says. “This credit isn’t given out of charity, however. A higher interest rate will increase your monthly payment and may lead you to pay thousands more over the life of your loan.”
For example, a 30-year fixed rate mortgage with a 4.75 percent interest rate in the amount of $300,000 results in a $1,565 monthly payment. Over the course of the loan, the borrower will pay $563,400, which includes $263,400 in interest. The lender may offer a 1 percent lender credit, which would result in the buyer’s closing cost being reduced by $3,000, in exchange for raising the interest rate to 5 percent. While that may seem like an easy way to save $3,000, one must also consider the long-term ramifications. The small .25 percent increase in the interest rate will raise the monthly payment to $1,610. Over the course of 30 years, that will result in the borrower paying an additional $16,200 in interest. What looked like a $3,000 savings ends up costing the borrower $13,200.
Lender concessions: promotions to get you in the door
Lender concessions are credits offered by the lender to help lower the financial obligations due at closing. They are typically a percentage of the loan amount and they can be used to cover some of the items that make up closing costs, like appraisal fees, origination fees, and title insurance.
While this can be helpful to those shopping for the most affordable mortgage, keep in mind that not all lenders offer concessions. That means that when you do find a lender offering a concession, there may be a catch.
Promotional credits are an example of this. Just like any other type of promotion, they are available only when certain criteria are met or certain products are chosen.
“The downside of promotional credits is that they may not be available if you don’t use the specific service provider or a specific product or package,” Yatin says. “When presented with a promotional credit, make sure you tease out the implications over the long run.”
Extra care should be taken when comparing credits and concessions offered by competing lenders. While rules issued in 2018 address the disclosure and treatment of lender credits, the industry has been slow to implement their provisions. As a result, there continue to be irregularities in how lender credits and concessions appear on loan estimate documents.
Over tolerance credits: money with no downside
Unlike the other types of credits associated with mortgage loans, over tolerance credits are not elective. Sometimes referred to as tolerance cures, these credits are mandated by mortgage disclosure rules when certain closing costs are higher at closing than they were projected to be on the loan estimate. The change in the estimate can be a result of either under disclosure on the initial loan estimate or valid changes that are not disclosed in a timely manner. There are no downsides to receiving an over tolerance credit, and you cannot opt out of getting one when it is due to you.
How do I decide if a credit is good for me?
Finding lenders who are willing to offer home buyers credits and concessions is easy. Deciding whether or not a credit or concession makes financial sense, however, can be complicated.
“Accepting discounts at closing in exchange for a higher interest rate is not necessarily a bad decision,” explains Yatin. “If a buyer does not plan to own the home for long, plans to refinance, or is short on money at closing, lender concessions can make sense. However, understanding what is best will often demand in depth comparisons of a variety of figures. Wise shoppers should turn to platforms like the Confer App to ensure that all important factors are considered.”
