Refinance guide lender credits vs paying points at refinance

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Understanding lender credits vs paying points at refinance

When you refinance a mortgage, lenders will offer ways to adjust your interest rate and closing costs. Two common options are paying discount points (buying points) to lower your rate upfront, or accepting lender credits (also called a credit or yield spread premium) that reduce your closing costs in exchange for a higher interest rate. Choosing between them depends on your goals, how long you’ll keep the loan, cash on hand, and tax considerations.

What they are and when each makes sense

Paying discount points

Discount points are prepaid interest you pay at closing to get a lower interest rate. One point typically equals 1% of the loan amount and can reduce the interest rate by a fixed amount (commonly 0.125%–0.25% per point, depending on market conditions and the lender).

When it makes sense: If you plan to stay in the home (or keep the loan) long enough to recoup the upfront cost through lower monthly payments, paying points can save you money long-term.

Lender credits

Lender credits are an amount the lender pays toward your closing costs in exchange for offering you a higher interest rate. The credit reduces what you pay at closing but increases your monthly payment over the life of the loan compared with a lower-rate option.

When it makes sense: If you have limited cash for closing or expect to refinance or sell in the short term, lender credits can reduce immediate out-of-pocket expenses.

Benefits and drawbacks

  • Paying points — benefits: Lower monthly payment, reduced total interest over the loan term, possible long-term savings if you keep the loan.
  • Paying points — drawbacks: Requires upfront cash, slower break-even point, less flexibility if you refinance or sell soon.
  • Lender credits — benefits: Lower or no out-of-pocket closing costs, easier cash flow in the short term, attractive if you won’t keep the loan long.
  • Lender credits — drawbacks: Higher interest rate and overall interest cost, potentially more expensive over time.

Costs and fees

Key cost items to compare:

  • Cost of points: One point = 1% of the loan amount. Example: on a $300,000 loan, 1 point = $3,000.
  • Rate reduction per point: Varies by lender and market — often 0.125%–0.25% per point. Ask the lender for exact pricing.
  • Lender credit size: Expressed as a dollar amount on the Loan Estimate/Closing Disclosure as a negative charge that offsets closing costs.
  • Closing costs: Origination, appraisal, title, recording, escrow, and other fees still apply; credits may cover some but rarely all fees and prepaid items.
  • APR: The Annual Percentage Rate incorporates fees and rate and is useful for apples-to-apples comparisons across different scenarios.
  • Taxes: Treatment of points for tax deductions varies — for a refinance, points are usually deductible over the life of the loan (amortized). Consult a tax professional for specifics.

Step-by-step process to choose between them

  • 1. Gather quotes: Ask several lenders for rate sheets showing the relationship between rate, points, and lender credits. Request the Loan Estimate.
  • 2. Compare APR and monthly payments: Use APR and monthly-payment estimates to see immediate and long-term cost differences.
  • 3. Calculate the break-even point for buying points: Divide the cost of the points by the monthly savings in payment to find months to recoup the cost. If you plan to keep the loan longer than that, paying points likely makes sense.
  • 4. Consider cash on hand and liquidity: If you don’t have funds to pay points, lender credits let you conserve cash.
  • 5. Factor in plans for the future: If you’ll sell, move, or refinance again within a few years, lender credits are often better.
  • 6. Confirm details on forms: Before closing, review the Closing Disclosure to confirm points and credits are reflected correctly and that APR and monthly payment match expectations.

Common pitfalls to avoid

  • Focusing only on the lowest interest rate without checking APR or total costs; points and credits affect APR differently.
  • Not calculating the break-even timeframe — paying points can be a loss if you move/refinance sooner than expected.
  • Confusing lender credits with “free” loans — credits reduce upfront costs but translate to higher interest over time.
  • Overlooking other loan features tied to rate (prepayment penalties, adjustable vs fixed terms) that affect value.
  • Not verifying that the credit covers the items you expect — some credits may not apply to certain fees.

Short FAQ

Q: Can I combine lender credits and paying points?

A: Yes. Lenders often provide multiple pricing options along a rate sheet where you can buy some points and accept some credits. Compare scenarios to find the best mix for your situation.

Q: How do I calculate the break-even point for points?

A: Break-even months = cost of points / monthly payment savings. Example: $3,000 for 1 point, monthly savings $50 → 3,000 / 50 = 60 months (5 years).

Q: Are discount points on a refinance tax-deductible?

A: For refinances, IRS rules typically require points to be deducted over the life of the loan (amortized) rather than fully in the year paid. Tax rules change, so check with a tax advisor for your situation.

Q: If I have limited cash, should I always take lender credits?

A: Not always. Lender credits solve short-term cash constraints but increase long-term costs. If you plan to stay in the home long term, paying some points might be the smarter financial choice if you can afford it.

Choosing between lender credits and paying points is a trade-off between short-term cash flow and long-term interest expense. Run the numbers, compare APRs, and match the option to your timeline and cash situation to make an informed decision.

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