Weigh the short-term savings versus long-term costs before making your decision.
Very basically, it’s a trade-off between you and the lender where you agree to pay a higher interest rate in return for less or no closing costs. You are expected to pay closing costs to finalize your loan application. It encompasses legal fees, underwriting fees, filing fees, and sometimes home appraisal and inspection costs.
On average, closing costs equal about 2%-5% of your chosen loan amount. For a $400,000 mortgage loan, for example, that’s an additional cost of $8,000 to $20,000. If you haven’t budgeted enough cash for closing costs, lender credits can help you take out that loan anyway. But be aware that the more lender credits your accept (i.e. the less you choose to pay in closing costs), the higher your new interest rate will be.
A slightly higher interest rate will matter more depending on your financial goals. If you are choosing a long-term loan (30 years), a higher interest rate won’t increase your monthly payments by much, but it will make your total loan repayment amount much greater. However, if you choose a short-term loan, even a slightly higher interest rate could significantly increase your monthly payments, but the total loan repayment amount would be about the same. Aside from loan term length, whether you get a fixed-rate or adjustable-rate mortgage loan also shapes the impact you’ll receive from lender credits.
If you only keep your loan for a few years (5 years or less), then a slightly higher interest rate won’t make much difference. Even if you take out a 30-year-term loan, you can choose to refinance after 5 years and avoid paying the larger interest amount altogether. Just keep in mind that refinancing also comes with closing costs.
Despite the many benefits, lender credits aren’t always the right choice for everyone. Keeping monthly payments low, for example, may matter more than the overall repayment amount. Low (predictable) monthly payments could allow you to save more each month, improve your credit score, and lower your debt-to-income ratio--all of which would improve your loan options the next time your refinance or take out a mortgage loan.
Like with every other facet of mortgage loans, comparing multiple offers is key. And since lenders each structure their loans and lender credits differently, be sure to compare them on equal footing. Some, for instance, will only cover origination fees while others might offer a no-closing-cost mortgage. Choose what makes the most sense for your situation and loan type.