How to choose a mortgage lender

In a nutshell

Choosing a mortgage lender is one of the most important steps in the homebuying process. But with so many different lenders to choose from, each offering different products and rates, how do you know which is best for you?

• The lender you choose will determine the terms and rate of your loan, based on several factors.
• There are seven different types of mortgage lenders you can use.

What is the role of mortgage lenders?

The primary purpose of a mortgage lender is to lend money to those who want to buy or build a new home. Mortgage lenders have their own underwriting guidelines to help them assess a potential borrower's creditworthiness and ability to repay their loan.

While some mortgage lenders exclusively deal with mortgage loans, others are part of a larger organization, like a bank or credit union, and offer many other financial products.

It’s also important to know that the relationship you build with your mortgage lender doesn’t end when you close your loan. Unless a different mortgage servicer purchases your loan after closing, the lender will also manage the repayment process. If you want to adjust your mortgage terms, you’ll deal with the same lender.

Importance of mortgage lenders

Real estate agents are essential because they guide you through the homebuying process. They do all the legwork to find homes matching your wish list. Mortgage lenders are another crucial part of this journey, because they’ll help you finance your home purchase. They’ll help you through the mortgage process, answering your questions along the way.

Types of mortgage lenders

There are seven different types of mortgage lenders. Choose the one that best suits your needs.

Retail lenders

When you think of a mortgage lender, you’re likely thinking of a retail lender. These are banks and credit unions, and part of their business is issuing loans directly to homebuyers.

They follow strict underwriting guidelines set forth by Fannie Mae and Freddie Mac, two government-sponsored enterprises that buy and sell most mortgage loans in the U.S. Retail lenders also handle the entire loan process internally, from underwriting to funding the loan. Retail lenders are ideal if you want a choice of several loan types.

Be aware that once your loan is closed, many retail lenders will sell the loans to investors on the secondary market, so your loan could be transferred to another servicer who you’ll make your mortgage payments to.

Direct lenders

Direct lenders are similar to retail lenders, except their focus is on home loans. Also, loans issued through a direct lender might close a little faster.

Portfolio lenders

Instead of selling the loans they underwrite, portfolio lenders will continue to hold onto loans within their portfolio. These lenders don’t adhere to the Federal Housing Finance Agency’s (FHFA) standards used by Freddie Mac and Fannie Mae and are more flexible with the terms they offer.

Online lenders

Online lenders conduct their entire business online without any physical locations. Because there is less overhead, many online lenders offer lower rates and fees to borrowers. The downside here is that you might not be able to talk to a real person to negotiate your loan.

Wholesale lenders

Wholesale lenders don't have any contact with borrowers. Instead, they fund loans and offer them to third-party banks, credit unions or mortgage brokers. A wholesale lender is responsible for setting the mortgage rate and terms, but all communication throughout the application and underwriting processes is done through the third party.

Correspondent lenders

Correspondent lenders originate, underwrite and fund loans without any third-party help. Once the loan closes, they typically sell it to an investor, who will then be the servicer for the loan.

Hard money lenders

Hard money lenders don’t follow standard underwriting processes, which allows them to close loans much quicker than other lenders. However, this also means hard money loans come with high fees and interest rates. These loans are meant for real estate investors who need funding for a house flip; they aren’t ideal for everyday borrowers.

How to choose a mortgage lender

Choosing the right mortgage lender can significantly impact your finances and homebuying experience. Here are a few tips to help you select the best lender:

Understand your financial situation

Before you start shopping with mortgage lenders, it’s crucial to understand your financial situation. This begins with your credit score, which directly impacts the interest rate you qualify for. The higher your score, the lower your interest rate will be.

You’ll also want to pull your credit report to check its accuracy. Once a year, you can receive a free copy of your credit report from each of the three major credit bureaus through AnnualCreditReport.com. Look for any inaccurate accounts or negative marks. These can affect your ability to get the best mortgage possible.

If your credit score needs improving, spend the next few months working on it. Remember that even the slightest change in the interest rate you qualify for could save thousands of dollars in interest payments over the life of a 30-year mortgage loan.

Determine how much you can spend

Once you’ve checked your financial position, you should figure out how much you can afford to spend on your new home.

As a good rule of thumb, you can follow the 28/36 rule. This means your monthly mortgage payments should be no more than 28% of your gross monthly income, and your total monthly debt payments shouldn’t exceed 36% of your gross monthly income.

A lender will help you determine your eligibility for a mortgage by going through the preapproval process. Your household income, revolving debt and other loans will determine your eligibility. A preapproval lets you know exactly how much you can borrow, and it signals to sellers that you’re a serious homebuyer.

Decide which mortgage product is best for you

There are many different mortgage products available. If you have good credit, you could opt for a conventional loan, which is available with as little as 3% down. Another option is a government-backed loan insured by the Federal Housing Administration (FHA), which has lower credit score requirements and is available with as little as 3.5% down. Mortgage insurance is required on all FHA loans and any conventional loan with less than a 20% down payment.

If you’re an active military service member, a veteran or eligible spouse, you could look into Department of Veterans Affairs (VA) loans. Additionally, loans guaranteed by the U.S. Department of Agriculture (USDA) are available for those looking to purchase a home in an eligible rural area. Both of these loans don’t require a down payment.

Once you know the type of loan that’s best for you, you’ll need to decide on the term. Most lenders offer 15-, 20- and 30-year loans. The longer your term, the lower your monthly payments will be, but the more interest you’ll pay over the life of your loan. Use a mortgage calculator to better understand which loan term fits your budget best.

Compare mortgage lenders and rates

To find the best deal on your mortgage, it’s a good idea to compare multiple lenders. You should check with at least three, but ideally five. Write down what each of them offers so you can easily compare them side by side. Pay attention to their interest rate and annual percentage rate (APR), but also consider mortgage points, origination fees, mortgage insurance, title insurance and closing costs. Each of these items can affect the overall cost of the loan.

Get preapproved

The next step in the process is to get preapproved. Some borrowers worry that getting preapproved by multiple lenders will negatively affect their credit score. However, any number of mortgage inquiries done within 45 days will only count as one hard inquiry.

That means you can go through the preapproval process with multiple lenders to understand what each can offer. To get preapproved, you’ll need to submit the following information:

• Social Security number for yourself and any co-borrowers.
• Two years worth of federal tax returns, W-2s and 1099s.
• Current employer and at least 30 days of paystubs.
• Savings, checking and investment account information.
• List of all current debt obligations, including loans, credit cards, child support, alimony and lien payments.
• Details on your planned down payment.
• Donor gift letter if you’re using a gift from a relative or friend for your down payment or closing costs.

How to compare mortgage loan offers

After getting preapproved, you’ll receive a loan estimate from each lender. Pay close attention to everything, including the fine print, so you know what they’re offering and what fees you’re responsible for. If things are unclear, ask for clarification.

Here are some key things you’ll want to pay close attention to:

Interest rate and APR

When most people compare loan options, they focus on the interest rate. While this is an accurate way to compare lenders side-by-side, it’s also important to know that rates change constantly until you pick a lender and lock in a rate. Plus, you need to look at the APR (not just the interest rate) to understand what the total cost of your loan will be.

As you compare the interest rate for each loan offer, pay attention to whether or not the APR includes mortgage or discount points. Points lower your interest rate by prepaying mortgage interest upfront. If points are included in your loan estimates, understand how much it will cost.

Fees

Fees can be confusing when comparing loan offers. While federal regulation requires specific fees to be included in the APR, there’s still some flexibility. Some lenders will list each of the fees individually, while others might lump them all together.

Pay particular attention to application, origination and closing fees. Third-party fees, such as recording and document fees, are mostly locked in, but lender fees can usually be negotiated.

Down payment assistance

When purchasing a home, you want your down payment to be as much as possible. However, you want to avoid using all of your savings. Discuss any down payment assistance programs that might be available through each lender or a local agency. These programs are typically available to first-time homebuyers but other borrowers may qualify, too.

How mortgage lenders differ from mortgage brokers

A mortgage lender is a financial institution, like a bank or credit union, that lends money directly to a potential homebuyer. Mortgage brokers are intermediaries who connect you to a lender, but they don’t lend money. Instead, they provide borrowers with lender options and help them choose the best loan for their financial situation.

If you use a mortgage broker, ask about their fees. Many times, the lender pays the fee directly to the broker, but occasionally, the broker might charge a flat fee to the borrower.

The AP Buyline roundup

Understanding the mortgage process and picking the best lender for your situation is one of the most important parts of buying a home. By minimizing the interest rate and fees on your loan, you could save you thousands of dollars over the life of your mortgage.

Frequently asked questions (FAQs)

Is it better to get a mortgage through a mortgage company or a bank?

Getting a mortgage through a mortgage company or bank is a personal decision. There are advantages to both. Any existing relationship at a bank could help you qualify for a lower interest rate, and there may be additional discounts. However, a mortgage company will likely have a more extensive selection of products and flexible borrowing guidelines.

Is it better to find your own lender?

If you’ve been through the homebuying process before and know what to expect, finding your own lender can give you more control. However, working with a mortgage broker might be a smart move if you’re inexperienced and would like some guidance through the process.

Where to get a mortgage?

You can get a mortgage through a bank, a specialized mortgage lender or a mortgage broker. There are advantages and disadvantages to each option.