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Using a Lender Credit to Subsidize Closing Costs

As mentioned previously, closing costs typically range from 3%-6% of your loan amount. A closing cost estimate I priced today for a client for a loan amount of $200,000 was $7,100 (3.55% of the loan amount). In this scenario the client was not paying any points for the interest rate.

The first option buyers have to help with these costs is to ask for the seller to contribute—your realtor will guide you through this part when you’re formulating an offer. Depending on the loan program, sellers are allowed to contribute from 3%-9% of the purchase price towards closing costs, prepaids, and points. I will get into that more specifically in a future post.

Let’s say your seller isn’t contributing towards closing costs, or he/she isn’t contributing enough to cover everything, and you would prefer not to pay for them out of pocket. You still have one other option: the lender credit. Just as you might pay a point (one percent of the loan amount) or two (two percent of the loan amount) for a lower interest rate, you also have the option to go with a higher interest rate and receive a lender credit of a point or two or three to use towards closing costs and prepaids.

To illustrate this, let’s say the zero point interest rate of the day is 3.00%. Based on a loan amount of $200,000, you might opt to pay ¼ point ($500) for a rate that is .125% lower, or 2.875%. If you wanted a lender credit of a point ($2,000) to use towards closing costs, you might go with a rate that is .25% higher than the par rate, or 3.25%. Two points towards closing ($4,000) might be a rate of 3.50% and three points ($6,000) towards closing might be a 3.75%. Below is an idea of how the different rates would affect your monthly payment:

Interest Rate

Charge/Credit for Rate

Principal and Interest Payment

2.875%

$500

$830

3.000%

$0

$843

3.250%

($2,000)

$870

3.500%

($4,000)

$898

3.750%

($6,000)

$940

So, what should you do? Pay more upfront for closing costs or go with a higher rate and cover some of them with a lender credit? The answer depends on your personal situation and how long you plan on staying in the house. You could save a lot in interest over the long run by choosing to go with the lower rate and paying for closing costs out of pocket.

If you live in Virginia and would like advice on which strategy would be the best for you, please feel free to contact me for a personal mortgage analysis.

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