Let’s talk about the mysterious advantages of lender credits. What exactly makes them so mysterious? What are they? We certainly do not hear much about them.
Lender credits go against the way we are supposed to think – which is, the lowest rate is the best. We’ve all heard about paying points. Points is basically a scenario where you give the lender upfront money – cash – in exchange for a lower overall interest rate. Well, what’s the reverse of that? Think of a lender giving you a little bit of cash upfront in exchange for a slightly higher interest rate. Lender credit’s are not for everyone, but sometimes they can be very attractive.
For a bondholder it’s a cash flow game. If they assume you’re going to keep that mortgage for let’s say seven years, then they’re willing to give you a little bit of money upfront to entice you into that higher interest rate. But the cool thing is, you don’t have to keep the loan that long, especially if market dynamics allow you to refinance.
There’s a good chance you can refinance with better rates in the future, but the risk is, what if rates never drop? What if you never get to reposition that loan? You could be stuck with that higher rate for the time you keep the home.
If you’re buying a house and you’re short on cash, lender credits are an amazing option to help absorb closing costs. Or if you’re refinancing a home, those same lender credits can help you in the same way.
Let me explain why this can be good. On a $500,000 loan, the lender gives you a $10,000 check at closing. You then say to the lender, I’m going to go ahead and pay you $200 a month in exchange for that $10,000. At some point, there’s a break-even period where your $200 a month equals that initial $10,000 that they gave you. In this case, it would be 50 payments or just over four years.
If you keep the loan longer than that, well, the lender made out on the loan. If you exited that loan and refinanced before that break-even period, you will have made out on that deal.
Another consideration is you could get a tax break on that extra $200 you’re paying. So really, in that previous scenario, that 50-month recapture period could be more like 60 months or 70 months, six or seven years. So, lender credits can be extremely compelling.
You should do the math to see if lender credits are good for you. Maybe it gives you that chance to invest in a home a little sooner to start building equity.