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How to Choose a Mortgage Lender
By Gabriel Rodriguez MONEY RESEARCH COLLECTIVE
If you’re among the 90% of homebuyers who favor the 30-year fixed-rate mortgage, your relationship with your lender will likely be a long-term one. With that in mind, choosing the right mortgage lender to do business with can be just as important as finding the right home.
But how do you go about choosing a lender when there are so many options available? The following guide aims to help you understand the most common types of loan options and lenders, so you can make the best-informed decision.
Steps to Choosing a Mortgage Lender
From working on your credit score to shopping around, the following steps are tried and true ways of finding the best mortgage lender for your situation and paying less for what you borrow.
1. Check your credit score
Everything from your chances of approval for a mortgage to the interest rate and the loan amount you may qualify for are tied to your creditworthiness, meaning your ability to repay what you borrow. And to determine your creditworthiness, lenders typically look at your credit score and the information on your credit reports.
There are many different credit reporting agencies, which means you have several different credit scores. The ones most mortgage lenders use, however, are FICO® scores. So when you apply for a mortgage, your lender will get your FICO® scores from the big three credit reporting agencies, Transunion, Experian and Equifax, and use the middle of the three scores to determine your eligibility and rate.
To qualify for a home loan, you’ll generally need a credit score between 500 and 700, yet that will depend on the type of loan you’re applying for and your lender’s requirements. For example, you could get an FHA loan with a score as low as 500 (provided you can put a certain amount of money down on your home), but lenders may set higher credit score requirements. Also keep in mind that the higher your credit score, the lower the interest rate you can get — and lower rates mean you’ll pay less in interest over the life of the loan.
When applying for a mortgage, it’s also important to check all three of your free annual credit reports and dispute any mistakes they might contain. According to the Consumer Financial Protection Bureau, incorrect negative items on your credit reports could artificially lower your credit score and hinder your ability to get the lowest possible interest rate.
2. Decide what kind of mortgage you need
There are several different types of mortgage loans. The most popular option among homebuyers is the conventional fixed-rate mortgage with a 30-year repayment term. Nevertheless, depending on your finances, credit score and down payment amount (among other details), this type of loan may or may not be the best option for you.
Let’s go over the most common alternatives:
Government-backed mortgages
As the name suggests, government-backed mortgages are insured by the federal government. This means that if a borrower defaults (fails to pay back their loan), the government agency that insures the loan will be responsible for covering a portion of the outstanding balance. Having this security means lenders take on less risk and, therefore, offer lower interest rates and be less strict with their credit and income requirements.
Government-backed loans include the following:
- FHA loans – Insured by the Federal Housing Administration, FHA loans are available to applicants with credit scores as low as 500 — if the borrower can provide a 10% down payment. Those with credit scores of 580 and above, however, can put just 3.5% down. These loans require both upfront and monthly mortgage insurance premiums.
- VA loans – Guaranteed by the Department of Veterans Affairs, VA loans are available to veterans, active military servicemembers and their families. VA-guaranteed loans don’t have minimum credit score or down payment requirements (although lenders may set their own) and borrowers don’t have to pay mortgage insurance, only a VA funding fee.
- USDA loans – Backed by the Rural Housing Service, a division of the U.S. Department of Agriculture, these loans help low-income home buyers purchase properties in eligible rural areas. They also feature competitive rates and don’t have a down payment requirement.
Conventional mortgages
Conventional mortgages are home loans that are not insured by the federal government. Conventional loans may be conforming or non-conforming, and you’ll generally need to pay private mortgage insurance if your down payment is under 20%.
- Conforming loans – Most conventional loans are conforming loans, meaning they meet the standards for purchase set by government-sponsored mortgage enterprises Fannie Mae and Freddie Mac. These loans also meet the conforming loan limits set by the Federal Housing Finance Agency (FHFA), which are borrowing limits that vary by area and change annually. These guidelines make conforming loans safer for lenders, so they feature lower interest rates than non-conforming loans.
- Non-conforming loans – Non-conforming loans are those that exceed the borrowing limits set by the FHFA or don’t meet Fannie Mae or Freddie Mac’s underwriting guidelines. Jumbo loans are one such type of non-conforming loan. They generally feature high interest rates and are available to borrowers with strong credit and income who want to purchase property in high-cost areas.
Fixed rates vs. adjustable rates
Besides choosing a type of mortgage, you’ll also have to decide between a fixed or an adjustable rate. Fixed-rate mortgages feature predictable monthly payments, so the risk of defaulting on this type of loan is lower. However, fixed-rate mortgages tend to have higher interest rates, so your principal and interest payments may be higher.
Adjustable-rate mortgages (ARMs), on the other hand, feature variable rates. While these rates are initially lower, they may fluctuate after a fixed-rate period, making your monthly payments unpredictable.
Shorter vs. longer loan terms
Along with your rate, you’ll also have to choose a loan term. There are many options available, but the most common are 30-year terms and 15-year terms.
Longer loan terms mean your mortgage balance will be spread out over a longer period, so your monthly payments will likely be lower — but you’ll also end up paying more in interest. A shorter term will mean paying less in interest but shouldering higher monthly payments.
To learn more about these and other term options, read our article on 15 vs. 30-year mortgages.
3. Get pre-approved
When you’re shopping for a home, getting pre-approved for a mortgage (as opposed to just getting prequalified) can help signal you’re a serious buyer — especially in a competitive housing market.
Pre-approval generally entails a hard credit inquiry, which can cause your credit score to take a small dip. However, if you get pre-approved with several lenders within a period of around 14 to 45 days, those credit pulls should count as one.
Besides looking into your credit, lenders will also verify your debt-to-income (DTI) ratio, assets and employment. This means you’ll need to provide the following:
- Tax return statements such as W-2 forms or 1099s
- Pay stubs and bank statements that validate your income and assets
- An employment verification letter (at least two years of employment history is preferred)
- Valid forms of identification (driver’s license and Social Security number)
- An estimate of the value of the home you wish to purchase
Once you get your pre-approval letter, it should be valid for anywhere between 30 and 90 days.
4. Compare mortgage lenders
You might be tempted to get a loan offer from just one lender and call it a day, but Freddie Mac reports that borrowers who get at least five rate quotes can save as much as $3,000 on their mortgage.
Regardless of how many quotes you get, the CFPB recommends you do an apples-to-apples comparison by requesting the same type of loan with the same features from each lender you reach out to. That means choosing the same type of mortgage, rate type, loan term and down payment amount.
When comparing mortgage offers, you should also factor in the following:
- Potential fees and closing costs
- Principal and interest payments
- Mortgage insurance payments (if applicable)
- Property taxes, homeowners insurance and potential HOA fees
- Upfront loan costs
- Whether or not you’re purchasing discounts points
- The length of the rate-lock period (if applicable)
Besides comparing rates and loan terms, look into the lender’s financial stability and reputation for customer service. After you close on your mortgage, the loan might be sold to a different lender or transferred to another loan servicer, but that isn’t always the case. And doing this kind of background check could help you avoid hassles down the road.
5. Always ask questions
Once you apply for a mortgage, you’ll be assigned a loan officer who will guide you through the process. Your loan officer is supposed to answer all of your questions, so don’t be afraid to ask about loan options, terms, fees, closing costs, etc. as many times as you need.
They should also be able to advise you on available down payment assistance programs and grants available in your area.
Understand the Various Types of Mortgage Lenders
You can get a mortgage from banks, credit unions or mortgage brokers. And many of these lenders now offer borrowers the option of completing their loan application (and sometimes even closing on their mortgage) online.
Direct lender
As the name suggests, direct lenders work directly with borrowers, underwriting and issuing loans without the involvement of intermediaries or third parties. Retail lenders (like Bank of America and Wells Fargo) fall under this category, but other direct mortgage lenders don’t offer banking services, such as Rocket Mortgage.
Dealing with a direct lender may lead to a shorter loan process and more effective communication.
Mortgage brokers
Mortgage brokers serve as intermediaries between lenders and borrowers. A broker may offer loan products from several different lenders, which could be helpful for borrowers who don’t have time to do the legwork of comparing different loan offers.
The downsides to opting for a mortgage broker, however, are that communicating with your lender and completing the loan process may take longer.
Nonbank mortgage lenders
Nonbank mortgage lenders are financial institutions that don’t offer banking services beyond lending money.
According to the U.S. Chamber of Commerce, the main benefits of doing business with a non-bank lender are a quicker application process and faster access to funds. The main drawback, however, is that these companies are newer in the market and their financial footing may not be as secure.
Mortgage marketplaces
Like mortgage brokers, mortgage marketplaces don’t lend money directly, but connect lenders with borrowers who meet their eligibility criteria. Since they work with dozens of partner lenders (sometimes more), marketplaces are a good fit for those wanting to compare several different loan offers by completing a single application.
How to Choose a Mortgage Lender FAQ
What credit score do mortgage lenders use?
According to Experian, most lenders use FICO® scores to determine borrowers' eligibility for a mortgage loan.
The three major credit bureaus — Transunion, Equifax and Experian — all use a different FICO® scoring model. This means that when you apply for a loan, your lender will get all three of your FICO® scores and base its lending decision on the middle of the three scores.
What do mortgage lenders look for?
Above all, mortgage lenders are looking for creditworthy borrowers who can repay their loans. This means that having a good credit score and credit history, a steady source of income and sufficient savings for a down payment are often necessary for qualifying for a mortgage and getting a competitive interest rate.
Nevertheless, there are many different loan programs available, some of which are flexible enough to accept poor credit scores (as low as 500) and low or no down payments. Some lenders are even willing to consider alternative credit and income data, so applicants without lengthy credit history or who have inconsistent income streams may still qualify for a mortgage.
How to shop for a mortgage lender
When shopping for a mortgage, you should:
- Have a clear picture of your finances and credit situation. This will help you narrow down your loan options.
- Learn more about the advantages and potential disadvantages of the loan options for which you may qualify.
- Decide on loan details such as the type of rate you're comfortable with (whether fixed or variable), the loan term and your down payment amount.
- Get mortgage pre-approval and compare offers from different lenders.
Many borrowers choose to work with financial institutions with which they already have an established relationship or ask friends, family or their real estate agent for recommendations.
Alternatively, you can also do your own research into different mortgage lenders. And if you don't know where to start, our list of the best mortgage lenders may be of help.
What to ask a mortgage lender
Technically, you should feel comfortable enough with your lender to ask any questions you may have about your loan or the mortgage process. You may also ask your lender to go through your loan estimate with you and help you understand the full cost of your loan.
In general, it's also good to ask:
- About the types of loans the lender offers (not all lenders offer all types of loans)
- About the different loan options available to you based on your credit and finances
- What the differences are between loan options
- What the upfront cost of borrowing will be
- Possible fees (prepayment, application, origination fees, etc.)
- Whether underwriting and servicing are done in-house
- Whether there are any down payment assistance options available to you
Does it matter what mortgage lender you use?
Since your relationship with your lender may last the length of your mortgage, potentially 15 or 30 years, it's also good to research your options carefully. Look for a lender that not only offers you a good mortgage rate and spares you unnecessary fees, but also offers you the level of support you need.
First-time homebuyers, for example, may benefit from doing business with a lender that offers 24/7 customer service and provides resources (calculators, articles, etc.) to help them understand their options.
Summary of How to Choose a Mortgage Lender
- To improve your chances of approval and get the best mortgage rates, you should first know your credit and income situation and work on your credit score if need be. This will also help you narrow down the types of loans you may qualify for.
- Choose a type of mortgage, a type of rate — whether fixed or variable — and a loan term to rate shop. Once you’ve decided on those details, get pre-approved with different mortgage lenders and compare loan offers for the same type of loan and similar terms).
- To get pre-approved, you’ll have to provide tax returns, bank statements and other documents that evidence your income and assets. Your lender will also carry out a hard credit inquiry.
- Besides looking for a good deal on your mortgage (competitive rates, no unnecessary or junk fees, first-time homebuyer and down payment assistance programs, etc.), look for a lender that offers the level of customer service you need.
- Opt to do business with a lender or financial institution you know and trust or get recommendations from friends and family. Alternatively, you can do your own research by reading online reviews and articles like our list of best mortgage lenders.
- Knowing and understanding your options can pay off during the mortgage process, so ask your lender as many questions as you need to before making a decision.