A borrower will pay closing costs and prepaid amounts when he takes out a mortgage on a home. When a lender offers a borrower credits for some of these expenses, the lender will pay them himself at closing. A lender does not have to offer a borrower a minimum or maximum credit towards these costs, but must provide credits promised before closing.
At closing, a lender, borrower and seller will transfer ownership of a property according to terms mutually agreeable to all parties. The borrower will pay closing costs, such as recording, credit report, application, appraisal, flood certification, and loan origination fees, to cover lender expenses. He will pay amounts in advance to the lender called prepaids for property taxes, mortgage insurance and advance mortgage payments.
Lenders may offer a borrower credits for closing costs and prepaids to compete with other mortgage lenders. A lender will receive tens of thousands of dollars in interest over the lifetime of a loan, making the credit a minor expense compared to anticipated profits. Lenders most commonly offer credits for mortgage applications if borrowers successfully complete the mortgage process, but may also offer credits for interest rates, origination charges and prepaid interest. Credits assure a borrower he will not overpay for fees, because neither the lender nor the borrower knows the expense of every closing cost and prepaid in advance.
The value of credits depends upon the competitiveness of the lending market in a geographical area. Lenders will typically offer small credits, but even generous lenders will rarely exceed a 3-percent credit on closing costs and prepaids. If a lender promises a borrower a credit that covers an amount larger than actual costs at closing, the borrower will not receive a refund for the difference. This situation occurs if the borrower talks the home seller down in price or has lower charges for closing costs than anticipated.
Lenders cannot usually take back credits once they promise them to borrowers. The U.S. Department of Housing and Urban Development requires U.S. lenders to give borrowers a Good Faith Estimate, commonly called a GFE, shortly after they submit mortgage applications. The borrower will also receive a HUD-1 settlement statement before or at closing that details exact charges associated with his mortgage. A lender cannot issue a GFE estimate for interest rate, origination or transfer tax credits that differs from actual credits on the HUD-1. Credits for recording charges cannot differ more than 10 percent.