A mortgage lender credit gives you a break on closing costs, but it isn’t free money. Before accepting a lender credit, it’s important to understand how credits work and what a credit means for your mortgage and costs overall.

What is a lender credit?

With a lender credit, a mortgage lender gives you money, either upfront or loaded in with the principal, to put toward closing costs in exchange for a higher interest rate. The rate increase varies from lender to lender. If you accept more than one credit, the rate will rise further.

The credit reduces the amount of money you need to pay upfront at closing. Although you’ll save initially, you’ll pay more over time in interest due to the higher rate.

The credit can only go toward closing costs; it can’t apply to your down payment or any other financial moves related to the mortgage, such as paying down debt to lower your debt-to-income (DTI) ratio. (Whether you’re getting a credit or not, scrutinize the closing costs to ensure they aren’t excessive. An origination fee for a mortgage, for example, typically only costs 1 percent of the loan principal.)

Lender credits vs. points

Mortgage points are the opposite of lender credits: A borrower can choose to pay points upfront in return for a lower interest rate. One point typically lowers the rate by 0.25 percentage points and costs 1 percent of the loan principal.

Because they represent the inverse of points, lender credits are sometimes referred to as “negative points.” Both points and credits are part of a complex structure mortgage lenders use to price loans.

It’s important to note that the option for credits or points isn’t an indication one lender is better or less expensive than another. Each lender determines interest rates and pricing based on several factors, some unique to the lender. That’s why it’s crucial to compare lenders based on annual percentage rate, or APR, which accounts for the interest rate as well as credits, fees and points. It’s also important to compare a variety of lenders whether or not they offer credits or points. To make it easier to compare, it can be helpful to break all costs out on a spreadsheet or other platform.

Example of lender credits and points

As an example, here’s how accepting or not accepting a credit and paying or not paying points plays out on a 30-year, fixed-rate mortgage:

Without credits or points With a credit With one point With two points
Amount borrowed $330,000 $330,000 $330,000 $330,000
Interest rate 5.6% 5.725% 5.35% 5.1%
Closing costs $9,900 $9,400 $13,200 $16,500
Monthly payment (excluding insurance and taxes) $1,894 $1,920 $1,842 $1,791
Interest paid in total $352,269 $361,727 $333,800 $315,382

As you can see, by accepting a lender credit, you’d save $500 on closing day, but have a higher monthly payment and pay more than $9,000 in interest over the course of 30 years.

In contrast, if you pay one point, you’d need to bring $3,300 more to closing, but have a lower monthly payment and save over $18,000 over the life of the loan. With two points, you’d need to come up with $6,600 more in closing costs, but save roughly $37,000 in interest total.

Are lender credits worth it?

If you have limited savings to pay for closing costs or want to preserve funds for other expenses — such as an emergency fund or home repairs — a credit might be worth accepting, with the trade-off being a higher rate. In the future, if the opportunity presents itself to refinance to a lower rate, you might be able to mitigate the increased interest. However, when you refinance, you’ll have a new set of closing costs to pay, so the new rate would have to be substantially lower to make up for the cost of credits.

A credit might also be useful if you’re refinancing in that it’ll allow you to reach the breakeven point quicker. The breakeven is the time it takes to recover your closing costs by way of the savings you obtained by refinancing. With lower closing costs, you’ll hit that breakeven sooner.

Some lenders might require you to have a specific amount of reserves, as well, that make it necessary for you to utilize a credit.

Remember that ultimately, though, a credit raises your interest rate, and the result is often much more expensive than the savings you get on closing day. If you need help covering closing costs, you might consider waiting to save a bit more, or looking into a homebuying assistance program. If you’re in more of a buyer’s market, you might even be able to get the seller to pay some of your closing costs.