Lender Credit, which type of loans have them and how they work...

If you ever wondered where the lender got the "lender credit," or LC from on your loan and how they were able to give you that credit then this article is for you.

Lender credits generally follow products that are sold on the secondary markets. This applies to government sponsored products with household names like Fannie Mae, Freddie Mac, Ginnie Mae, and even some private mortgage products as well.  The banks that do not sell their loan on the secondary markets are generally called "portfolio," lenders. The term just means they keep or portfolio their loans in house. This is why portfolio lenders generally do not offer a lender credit (below explains why portfolio loans have no LC).

With secondary markets, after funding, the loans are bundled together into packages and sold as debt instruments or bonds to the market. These bonds control the supply and demand of money in the mortgage markets and this is why rates fluctuate up and down daily. 

When there is lots of demand and people buy lots of mortgage bonds the yields or "rates," as we commonly know it are driven downward because there is a lot of money pouring in so the market doesn't have to offer as "high," of a rate to attract that money. However, when comparable investments are hot, people often leave or sell their fixed income and mortgage bonds and go to investments in other areas like stocks, real estate, and businesses. This causes a flight of money or capital to leave the market so rates offered have to be raised to keep up with demand as supply drops. This alone with other smaller factors are generally what causes rates to move up & down.

The lender credit is generated when a borrower elects to choose a rate that is above the current market rate on that given day. An Example is if today's market rate is 3.875% with no fee's and the borrower elects for a 4.25% rate. He/She may receive a 1.25% (percentage of the loan amount) lender credit towards the borrowers closing costs or prepaid tax/insurance or interest costs. The lender credit cannot be taken as cash back so unused LC is forfeited.

This Lender credit in application can  be very beneficial to help improve investment returns, lower the effective cost of financing, or to even save deals where the buyer has marginal cash on hand to close (LC used to pay closing costs).

Some Examples where a lender credit or LC can be used:

- FHA primary residence loans an LC of 2-3% can be generated (means loan amount X 2-3% credit) when you raise the rate .375 - .50% above the going market pricing. So if market rate was 3.625% you could take it up to 4.125% to generate $12,000 dollars of credit on a $400,000 loan as an example. This credit can be use to pay closing costs or upfront MIP from FHA or other items allowing a buyer to come in with a lot less "cash to close," than he/she would have otherwise needed to bring in.

- Conventional loans often times have monthly mortgage insurance when borrowers put down less than 20% so a strategy could be to take .250 to .375% higher rate to absorb the .75% annual premium for mortgage insurance as a short term strategy to payoff or eliminate the MI on a loan for the life of the mortgage. Some will say the rate may last forever while the MI may fall off in year 5, why take a higher rate and there a few reasons such as the borrower may be in such a high income bracket that they cannot write off mortgage insurance (over 110k AGI), or the borrower plans on this property as a short term strategy and long term implications do not matter as much since the property may be sold in the future, or the buyers are on a strict monthly budget and will forgo future potential benefit for today's assured payment with no monthly MI and a tad higher rate.

- VA loans - The LC can be used to absorb the VA Funding fee of 2.15% up to 3.30%, as a short term strategy this is a huge reduce in cost of the over all financing of the VA loan program. VA loans, like FHA loans, have very high amount of lender credit for every .125% rate increase you elect for so its pretty easy to generate thousands if not tens of thousands of LC from raising just .25 to .375% depending on the size of your loan amount.

- and a multitude of other creative ways as well.

Let me know if you have any questions about lender credits or strategies on how to utilize them.