You’re buying a home and you need a mortgage. Congrats! But how do you choose the right lender who will offer the best deal and great customer service for what will probably be the largest purchase of your life?
You’ll find no shortage of banks, online lenders, mortgage brokers and other players eager to take your loan application, and here’s everything you should know about choosing the one that’s right for you.
Types of lenders
Direct lenders are banks, credit unions, online entities and other organizations that provide mortgages directly to consumers, so you won’t have to pay a mortgage broker to shop around for the best rates. With a direct lender, you can easily do that on your own for free.
Benefits of a direct lender: Because a direct lender offers its own loans, it keeps most of the mortgage process in-house from application to processing, so you can ask the lender questions about rates, terms, fees and more. You can compare these variables between multiple direct lenders to get a sense of what’s best for you. As you shop around, speak to lenders about their rates, terms, fees and other requirements, like down payments.
Risks of a direct lender: Rates and terms can vary widely from between lenders. You may qualify for two loans of the same size, but the rates and terms of each offer may, so you could end up with a more expensive or complex loan if you don’t pay attention to the fine print. This is one of the many reasons why it pays to comparison shop with multiple lenders.
Other types of lenders
Of course, you don’t have to work with a direct lender. There are several other ways to shop for and secure a mortgage, and here are some of the most common options.
Mortgage brokers: Brokers are independent, licensed professionals who act as matchmakers between lenders and borrowers. Brokers are usually paid by either the borrower or the lender and charge a small percentage of the loan amount (generally 1 to 2 percent) for their services. They do not fund loans, and they don’t set interest rates or loan origination fees, or make lending decisions.
Correspondent lenders: These lenders originate and fund their own loans but quickly sell them to larger lending institutions on the secondary mortgage market after the loan closes.
Wholesale lenders: Unlike direct lenders, wholesale lenders never interact with borrowers. They usually work with mortgage brokers and other third parties to offer their loan products at discounted rates, and rely on brokers to help borrowers apply for a mortgage and work through the approval process.
Portfolio lenders: These lenders originate and fund loans from their clients’ bank deposits so they can hold on to the loans and not resell them after closing. Typically, portfolio lenders include community banks, credit unions and savings and loans institutions.
Hard-money lenders: Hard-money lenders are private investors (an individual or group) who provide short-term loans secured by real estate. While traditional lenders look closely at your financial ability to repay a mortgage, hard-money lenders are more concerned with the property’s value to protect their investment. Hard-money lenders typically require repayment in a short time frame, usually one to five years. They also generally charge steeper loan origination fees, closing costs and interest rates, as much as 10 percentage points higher than conventional lenders do.
How to find the best mortgage lender
To find the best mortgage lender, you need to shop around. Consider different options like your bank, local credit unions, online lenders and more. Ask each of them about rates, loan terms, down payment requirements, property insurance, closing cost and fees of all kinds, and compare these details on every offer. Before you start shopping, there are a few steps you can take to get the best rate.
Step 1: Strengthen your credit
Long before you start applying for mortgages, give your finances a checkup, and fix them, if needed. This means pulling your credit score and credit reports.
Once every 12 months, you’re entitled to a free credit report from each of the three main reporting bureaus – Experian, Equifax and TransUnion – by visiting annualcreditreport.com. If you have a lower-than-expected credit score, look through your credit reports for errors, late payments, delinquent accounts in collections and high balances.
Paying down each of your credit cards below 30 percent of the available credit and making on-time payments are the best ways to improve your score, says Jason Bates, director of sales, purchase division, at American Financing, a national mortgage lender based in Aurora, Colorado.
Having a solid credit score tells lenders you can be trusted to pay your debts on time, so they’ll be comfortable doing business with you and will offer you favorable rates to seal the deal.
In addition to solid credit, lenders want to see that you can handle your existing debt along with a new mortgage payment, so they’ll look at your debt-to-income ratio. This formula adds all your monthly debts and divides it by your gross monthly income to get a percentage.
Many lenders require a debt-to-income ratio below 43 percent, though some loan programs allow up to 50 percent. To keep your DTI ratio manageable, avoid taking on new loans or making large purchases on credit cards for at least three months before applying for a mortgage. You should stick to this rule until you’ve finalized your mortgage, as lenders can pull up your credit report throughout the application process until you close on the loan.
Why this is important: Simply put, you stand to get a better rate with a higher credit score. A lower rate means smaller monthly payments.
How this affects you: A lower interest rate means you pay less to borrow money.
Step 2. Determine your budget
An important part of finding the right mortgage is having a good handle on how much house you can afford. Lenders may let you qualify for a loan that would max out your budget and leave you no wiggle room for unexpected expenses, but taking out such a mortgage may be a bad financial move.
Lenders preapprove you based on your gross income, outstanding loans and revolving debt, Bates says. However, they don’t look at other monthly bills, such as utilities, gas, day care, insurance or groceries, in their calculations.
To get a more accurate idea of what you can afford, factor in these kinds of expenses and your other financial goals. Look at your monthly net income to calculate how much you should spend on a mortgage payment.
“Make a line-item budget for all your monthly expenses, and be conservative about the monthly mortgage payment,” says Bates, who adds that this is especially crucial for first-time homebuyers who may not get their ideal home right away.
Why this is important: By taking a close look at your budget, you’ll know how much of a monthly mortgage payment you can handle. This can give you peace of mind and help you determine which mortgage lender is offering terms that are right for you.
How this affects you: If you don’t budget carefully, you could unwittingly close on a mortgage you can’t afford. That can lead to missing payments, paying more in interest and even potentially to losing your home.
Step 3. Know your mortgage options
A key aspect of finding the best mortgage lender is being able to speak their language, including knowing the different types of mortgages. Some upfront research can also help you separate mortgage facts from fiction.
“Traditionally, when it comes to getting a mortgage, a lot of peoples’ first thoughts are to go to a bank or that they need a 20 percent down payment to afford a home,” says Mat Ishbia, president and CEO of United Wholesale Mortgage. “That’s an outdated way of thinking.”
Many lenders offer conventional loans with as little as 3 percent down, and some government-insured loans require no down payment while others require just 3.5 percent down. Consider FHA loans and USDA loans, and if you’re a veteran, look into VA loans.
Keep in mind that if you put down less than 20 percent, many lenders will charge higher interest rates and may require mortgage insurance.
Step 4. Compare rates and terms from multiple lenders
Settling on the first lender you talk to isn’t the best idea. In fact, you want to rate-shop with lenders of different kinds – banks, credit unions, online lenders and local independents – to ensure you’re getting the best deal on rates, fees and terms. You should also try to find a lender that communicates the way you prefer, whether it’s online, via text or in person.
If you don’t shop around, you could leave money on the table, according to research from Freddie Mac published in 2018. In fact, borrowers could save an average of $1,500 over the life of their loan by getting at least one additional rate quote, and an average of $3,000 by getting five quotes, Freddie Mac found. However, nearly half of all homebuyers do not rate-shop during their mortgage search.
You can compare mortgage rates and lenders on Bankrate.com.
Another option to consider: working with a mortgage broker. A mortgage broker can do the legwork for you by evaluating your application and gathering quotes from multiple lenders who closely match your needs. See how the loan offers from a broker compare against those you find on your own. Look at differences in rates, fees, points, mortgage insurance and down payments to compare what your bottom-line costs will be.
Applying for a mortgage preapproval with three or four different lenders, or having a mortgage broker do this legwork for you, gives you an apples-to-apples comparison on loan offers. It’s really the only way to get accurate loan pricing because lenders do a thorough review of your credit and finances.
Lenders may have different documentation requirements for preapproval. Generally, you’ll need to provide several details, such as:
Driver’s license or other government photo ID.
Social Security numbers for all borrowers (to pull credit).
Residential address history, as well as names and contact information for landlords in the past two years.
Pay stubs from the past 30 days.
Two years of federal tax returns, 1099s and W-2s.
Printouts of bank statements for all accounts for the past 60 days.
List of all financial accounts (checking, savings, brokerage accounts, 401(k) and other retirement savings plans).
List of all revolving and fixed debt payments, including credit cards, personal and auto loans, student loans, alimony or child support.
Employment and income history, along with contact information for your current employer.
Down payment information, including the amount, source of the funds and gift letters if you’re receiving help from a relative or friend.
Information on any recent liens or legal judgments against you or other borrowers, such as IRS actions, bankruptcy, collections accounts or lawsuits.
Be careful: A mortgage preapproval doesn’t mean you’re in the clear. Lenders can re-check your credit, employment and income histories and your assets at any time during the process. If you take out a new car loan, for example, that changes your financial picture and can derail your mortgage.
Ishbia says borrowers should “hold tight” after preapproval and avoid opening new lines of credit, moving around money in your bank accounts and changing jobs before – and during – the buying process.
Step 6. Read the fine print
We get it: Mortgage documents make your eyes glaze over. But if you don’t read them closely and there are any errors or surprises, you could feel buyer’s remorse later. The Consumer Financial Protection Bureau created a thorough explainer on the loan estimate form lenders are required to give you within three days of receiving your mortgage application.
Pay close attention to your interest rate, monthly payments, lender and loan processing fees, closing costs and the down payment amount. These items shouldn’t change dramatically from preapproval to closing if your credit and financial profile stay the same.
Lenders sometimes offer credits to help lower the amount of cash due at closing. Beware, though: These credits can push up the interest rate on your loan, which means you’ll ultimately pay more in interest as a result.
As you compare loan estimates from different lenders, you’ll see a slew of third-party costs, such as lender’s title insurance, title search fees, appraisal fees, recording fees, transfer taxes and other administrative costs. You can negotiate some of these closing costs, but know that lenders don’t generally set the fees for third-party services.
Always ask questions if you don’t understand certain fees or you spot errors in the paperwork (such as a misspelled name or a wrong bank account). Getting ahead of any issues early can save you a lot of headaches later.
Why you should shop around
Shopping around helps you find the best rates, and you can also compare other costs such as fees, down payment requirements and insurance. You can use this information to your advantage. To seal the deal, a lender may lower some of these if a competitor is offering something better. According to a study by Fannie Mae, more than a third of homebuyers who received multiple quotes negotiated lower interest rates. They also lowered costs on insurance, origination fees and appraisal fees.
Doing your homework on the basics of mortgage lending early on can set you up for success, and help you get better acquainted with the different types of mortgage lenders out there. Mortgages are not one-size-fits-all products, so you need to know how they work and how they differ from one another. This will help you find the mortgage lender and loan that offers what’s best for your situation.
After you’ve obtained your mortgage, take a breather. You just took a major step. But it’s important to keep your credit clean. Avoid taking out another loan or opening a new line of credit, and try not to make any big purchases. You now have a new financial obligation to tackle, so prioritize it.