Lender Paid Closing Costs: Save Now or Pay More Later?

Lender-paid closing costs or lender credits are arrangements in which a mortgage lender covers closing costs in exchange for higher monthly payments. These types of loans are sometimes called no-closing-cost mortgages because the borrower doesn’t have to pay up-front closing costs.

Lender-paid closing costs can be helpful if you’re buying a house but don’t have enough cash on hand to cover the closing costs. The trade-off for a no-closing cost mortgage is that you pay back the lender credits and therefore pay more over the loan term than you would if you paid the closing costs.

Most lenders offer closing cost credits in some form. However, the lender credits you receive depends on the value of the loan and other financial factors, like your credit score, down payment, debt-to-income ratio, and broader market conditions.

What are lender-paid closing costs?

With lender credits, the lender partially or fully covers your mortgage closing costs. There are two primary ways they can do this:

1. The lender gives you a credit for closing costs in exchange for a higher mortgage interest rate.
2. The lender rolls closing costs into the total value of your loan.

In both cases, you trade lower upfront costs for higher monthly payments. You’ll also end up paying more in interest over the loan term.

It’s important to distinguish lender credits on closing costs from seller concessions. Lender credits are given by the lender, while seller concessions are closing costs that the seller pays. They are also distinct from negotiating down lender fees during closing.

In some ways, the term “no-closing-cost” mortgage is a bit of a misnomer: These mortgages still have closing costs; you just don’t pay for them immediately. Instead, the cost is more spread out and accounted for by the higher monthly payments.

Some quick general closing costs questions

How much are closing costs?

Home buyer closing costs usually range from 3–5%.

Home sellers should expect to pay 1–3% in closing costs. That doesn’t include real estate commission fees, though. Sellers generally pay another 5–6% of the home sale price in realtor commission at closing if they are covering the buyer’s agent commission. Working with a low-commission realtor is one way sellers can save on closing costs.

Sellers are not obligated to pay for the buyer’s agent fees, and this is always negotiable. That said, in most markets, sellers do pay for both the listing agent and the buyer’s agent commission.

What fees are included in closing costs?

Closing costs include all kinds of fees, like loan fees, taxes, and other transaction-related costs. Your exact closing fees will depend on your location, sales contract, and other factors.

Typically, you can expect buyer and seller closing costs to cover the following fees:

Why do I have to pay closing costs?

Closing costs cover several kinds of fees for your home purchase. Your closing costs will take care of important items like legal fees, property taxes, and more. Plus, your closing costs will help pay for things you probably care about ― like a home appraisal and inspection.

What if I can’t afford closing costs?

If you can’t afford closing costs, you can try to get someone else to pay them for you. You can ask your lender for a no-closing-cost mortgage, for instance. Or you can ask the home seller to help with closing costs. You can also look into home buyer rebates to save thousands at closing.

Your other option? Save up and be prepared to pay for your own closing costs. Lender-paid closing costs can end up costing you a lot more in the long term. So if you can save up enough to pay for closing costs, you might find the savings are worth the wait — especially if you plan on staying in your home for a while.

How lender-paid closing costs work

There are two main ways a lender can pay closing costs with lender credits.

Lender credits via higher interest rate

With this method, the lender applies credits to lower closing costs in exchange for higher interest rates. You can think of this option as the opposite of mortgage discount points — instead of buying points for a lower interest rate and paying more closing costs, you pay less at closing for a higher interest rate.

The credit is usually expressed in terms of “negative points,” where one point is equal to 1% of the sales price. A single negative point typically raises interest rates by about 0.25%. For instance, a $3,000 credit on a $300,000 loan at 6.50% would raise the interest rate to 6.75%.

Rolling fees into the loan balance

The other option is to add the closing cost credit to the loan principal. For example, the lender would add a $3,000 credit to the $300,000 loan for a total of $303,000. This option does not necessarily impact your interest rate but can increase your loan-to-value (LTV) ratio.

Both lender credit options increase the amount of interest you pay, either by increasing the interest rate or by increasing the loan principal.

Pros and cons of lender-paid closing costs

Here are some of the pros and cons of lender-paid closing costs.

Ultimately, there are some tradeoffs to taking lender credits. Using lender credits to raise interest rates or increase the loan principal means you pay more money. But the cash savings can be used for other purposes, such as making a larger down payment.

Let’s look at some hypothetical numbers to compare interest rates, monthly payments, and total interest paid with and without lender credits.

As you can see in the table, monthly payments with the credit are about $57 more, and interest expense is about $20,000 more over the lifetime of the loan. At this rate, you’ll save money until about the 5-year mark in the house.

When does it make sense to have a lender pay your closing costs?

When should you consider using lender credits to pay for closing costs? The most obvious scenario is if you are short on cash to cover all the closing costs. By accepting a lender credit, you can lower those closing costs so you won’t have to put up as much cash when you close the sale.

That additional cash can then be put toward other things, like a larger down payment to reduce the loan amount. A larger down payment lowers the loan-to-value ratio, which can reduce lender risk. A lower loan principal also means paying fewer (or potentially eliminating) private mortgage insurance costs.

Also, lender credits can be a good idea if you plan to sell or refinance relatively quickly. Because you’ll be in the house for less time, you can minimize closing costs and avoid the higher long-term interest payments.

On the other hand, lender credits might not be a good idea if you plan to stay in your home long-term without refinancing. The longer loan timeline means you’ll have to pay the higher interest, which could outweigh savings. Lender credits may also be unnecessary if you qualify for certain assistance programs that can help you cover closing costs.

How to get lender paid closing costs

Not all lenders will offer lender credits, so you may need to shop around and compare offers. All other things being equal, the better your financial qualifications are (e.g., income history, credit score, etc.), the higher the chance you’ll qualify for lender credits.

You can also compare mortgage offers using a mortgage calculator to see  how much you’ll pay with and without lender-paid closing costs.

There is no universal maximum lender credit for closing costs, and what you can get will depend on the specific loan type and lender. Depending on where you live, lenders might cap the amount of lender credits to comply with regulations.

You may be able to negotiate lender credits with one lender if you have offers from others. Mortgage lenders are usually willing to negotiate things like closing costs if you show them a better deal from competitors.

More ways to lower your closing costs

Lender credits aren’t the only way to lower closing costs. Below are some additional strategies/methods you can try.

Seller concessions

With seller concessions, the seller absorbs a portion of the closing costs. Typical seller concessions range between 3% to 6% of the sales price, though different types of loans limit allowable closing cost contributions. Sellers might offer concessions to attract buyers in a tight market.

First-time buyer grants/assistance programs

Depending on your income and where you live, you may be eligible for first-time grant and assistance programs. These programs can offer interest-free loans or grants so first-time buyers can cover closing costs.

Negotiating lender fees directly

You can often get lenders to reduce their fees by negotiating directly. Many lenders are willing to match or beat fees from competitors, so it helps to shop around and consider multiple options.

Long-term strategy: Using discount points vs. lender credits

If you have additional cash to contribute to closing, one option is buying discount points to lower your interest rate. Discount points typically cost 1% of the loan value and lower rates by between 0.125% and 0.25%. You can think of discount points as the opposite of lender credits.

The bottom line on closing costs

Like most mortgage decisions, whether or not to use lender credits for closing costs depends on your financial situation and investment timelines.

For buyers who have little cash upfront and plan to refinance or sell their houses, lender credits may be a good idea to reduce closing costs and avoid the worst impacts of higher interest.

However, those using lender credits will need to balance the lower closing costs with higher monthly payments.

Certain strategies, like using cash savings from credits for a larger down payment, may reduce other costs, such as private mortgage insurance. But the upfront savings from lender credits might not be worth the increased interest.

We highly recommend using a mortgage calculator to play with values and see the difference between using lender credits and no lender credits. By adjusting value, you can find a balance that works for your financial situation.

Use Clever to shop with lenders and agents

Being diligent in your search is the best way to get the best deal on lender credits and mortgage interest. You can use Clever to search for local top agents, so get started today!

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