How to choose a mortgage lender: 6 tips

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Finding the best mortgage lender is a crucial step in the homebuying process. But with so many options available, how do you know which lender is right for you? From understanding your mortgage options and comparing rates from multiple lenders, here’s how you can find the best mortgage lender.

How to find the best mortgage lender

To find the ideal mortgage lender, you need to shop around. Studies show that borrowers who compare the details of at least three lenders’ offers save a considerable amount over those who just go with the first institution they come across.

But before you start shopping, here are some tips that can help you know how to find the best mortgage lender.

Step 1: Strengthen your credit score

Before beginning your homebuying journey, check your credit score and ensure there are no mistakes in your credit history that might negatively impact your score. If your score could use some work, prioritize improving it before applying for a mortgage. For example, paying your bills on time contributes positively to your credit history — a major determinant of your overall score.

You can also reduce your credit card balances to lower your credit utilization ratio, preferably to below 30 percent. In addition, avoid opening new accounts or closing old ones before applying for a mortgage, as these activities can lower your score. By taking these steps, you can improve your credit score, which in turn can help you secure a mortgage with a lower interest rate and favorable terms.

You can get a free weekly credit report from each of the three main reporting bureaus (Experian, Equifax and TransUnion), which you can get through AnnualCreditReport.com.

Step 2: Determine your budget

Lenders determine a preapproval sum based on your gross income, outstanding loans and revolving debt. However, they don’t consider other monthly bills — utilities, gas, day care, health insurance — in their calculations. As a result, the lender could prequalify or preapprove you for a loan that would max out your budget, leaving no room for unexpected expenses or even expected ones (like food), leaving you house poor. This would be a bad financial move.

Instead, to determine your household budget, begin by understanding how much you can afford based on your income, remembering the 28/36 rule: Housing costs should ideally not exceed 28 percent of your monthly gross income. Gather the details of your income, existing debt, savings and potential property taxes and insurance costs. Don’t forget to factor in potential lender fees, closing costs and your down payment size. Create a detailed budget, ensuring your mortgage and other debts do not exceed 36 percent of your gross monthly income (the back half of the 28/36 rule).

You can use Bankrate’s affordability calculator to estimate the home price and monthly mortgage payment you can comfortably manage.

Step 3: Know your mortgage options

Mortgages come in various forms, often with options about the loan term, interest rate type and loan type. Common loan terms are 15 years or 30 years, with longer terms generally resulting in lower monthly payments but higher total interest costs. Interest rates can be fixed — meaning the rate and monthly payments stay the same throughout the term — or adjustable, meaning the rate may start lower but can change over time based on the prevailing financial markets.

The loan types you can get include:

• Conventional loan
• Jumbo loan
• Government-backed loans, like FHA, VA and USDA loans

You can get a conventional loan for as little as 3 percent down, but you’ll need to pay for private mortgage insurance (PMI) with a down payment below 20 percent. If you qualify, you could get a USDA or a VA loan for no money down. FHA loans have looser credit score requirements, and jumbo loans can be beneficial for people seeking to buy a home in an expensive area.

Overall, each loan option affects your down payment requirement, total loan cost and monthly mortgage payment and your risk level, so it’s important to consider your needs and financial situation carefully when choosing a mortgage.

Step 4: Compare rates and terms from multiple lenders

Comparing rates and terms from different mortgage lenders — banks, credit unions and online lenders — is key to finding the best deal. While shopping around (preferably with at least three lenders), be sure to compare the following:

• Loan terms (loan amount, interest rate, annual percentage rate, etc.)
• Down payment requirements
• Mortgage points
• Mortgage insurance
• Closing costs
• Other lending fees (if applicable)

When comparing loan estimates from each lender, focus not just on the interest rate but also differences in expenses and fees, such as closing costs and mortgage points, which impact the overall cost of the loan. Don’t hesitate to reach out to your loan officer or broker for clarification on anything that’s unclear.

Remember, shopping around for the best loan won’t significantly lower your credit score, as multiple mortgage inquiries within a 45-day period count as one inquiry on your credit report.

Step 5: Get preapproved for a mortgage

Getting a mortgage preapproval with three or four different lenders is really the only way to get a firm sense of what size loan you qualify for. With a preapproval, lenders do a thorough review of your credit and finances.

It’s a fairly elaborate application. While the documentation requirements for preapproval can vary, you’ll generally need to provide:

• Photo IDs and Social Security numbers for all borrowers
• Pay stubs from the past 30 days
• Two years of federal tax returns, 1099s and W-2s
• Printouts of statements for all financial accounts (checking, savings, brokerage accounts, 401(k) and other retirement savings plans) for the past 60 days
• 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

Be mindful: A mortgage preapproval doesn’t mean you’re guaranteed the money, or even that amount of money. That doesn’t happen until after you formally apply for a mortgage on a specific property, and lenders do a deeper dive into your finances — a process called underwriting. They can re-check your credit, employment and income histories and your assets at this time.

Step 6: Read the fine print on your loan estimate

Within three days of applying for a mortgage, your lender must provide you with a loan estimate. Thoroughly reading the fine print in your loan estimate helps you understand the exact terms of the loan, including the interest rate, repayment term, fees and whether there is a balloon payment. Understanding these details can help you avoid surprises that could disrupt your budget, damage your credit or result in the loss of your home if you fail to meet your obligations.

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 fee, appraisal fee, recording fee, transfer taxes and other administrative costs. You can negotiate some of these closing costs, but know that lenders don’t determine the fees for third-party services — just their own.

Money tip: Financial institutions sometimes offer lender credits to help lower the amount of cash due at closing. Be aware, though: These credits can push up the interest rate on your loan, which means you’ll ultimately pay more.

Always ask questions if you don’t understand certain fees or spot errors in the paperwork (such as a misspelled name or a wrong bank account number). Getting ahead of any issues early can save you a lot of headaches later.

Before signing on the dotted line, read your mortgage agreement as thoroughly as you would any other legally binding document so you don’t miss something that could give you buyer’s remorse.

Questions you should ask a mortgage lender

When shopping for a mortgage, there are several questions to ask your lender about the process and its loan options. Here are a few:

• What paperwork will you need to provide?
• How long does its rate lock last?
• How long do its mortgages typically take to close, and how frequently does it fail to close a loan in time?
• What are the steps in its underwriting process, and will you be able to complete everything online, by mail or in person?

Types of mortgage lenders

There are six main types of mortgage lenders. Which type is best for you depends on the level of hands-on interaction you like, the legwork you’re willing to do and any restrictions you have on loan types you’ll consider.

Direct lenders

Direct lenders are banks, credit unions, online entities and other companies that do business with borrowers, providing them with mortgages directly (hence the name).

They create and fund mortgages and either service them (meaning administer and manage the repayments) or outsource the servicing to a third party. They also establish loan rates and terms; these can differ significantly depending on which lender you work with.

These lenders typically have competitive rates and fees, and you’ll work with the same loan officer through the whole process. However, you’ll have to do the comparison shopping on your own.

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.

These lenders may offer easier approvals and favorable loan terms, but you need to work with a broker (or another mortgage company) to get a loan from a wholesale lender; you can’t apply directly.

Mortgage brokers

Mortgage brokers are independent, licensed professionals who serve as matchmakers between lenders and borrowers.

Brokers usually charge a small percentage of the loan amount (generally 1 to 2 percent) for their services, which the lender pays for (but passes on to you as part of the cost of your mortgage). They don’t fund loans or set interest rates or fees, or make lending decisions.

Brokers make comparison-shopping easy because they do the legwork for you. They may find opportunities you couldn’t, since some lenders work exclusively through brokers (see “Wholesale lenders” below). However, you might see higher rates to compensate for the commission the lender has to pay or only get offers from lenders in that broker’s network.

Correspondent lenders

Correspondent lenders originate and fund their own loans but quickly sell them to larger lending institutions on the secondary mortgage market after the loan closes.

These lenders offer a wide range of loan products and may have low rates, but you might wind up having to deal with a new, unexpected loan servicer. Correspondent lenders also tend to have stringent requirements for borrowers.

Portfolio lenders

Portfolio lenders originate and fund loans from their clients’ bank deposits. They generally hold onto the mortgages, instead of reselling them after closing. Typically, portfolio lenders include community banks, credit unions and savings and loan institutions.

These local lenders may have better service and can approve borrowers with atypical financial situations. However, their loans typically have higher rates or fees and they may not be able to loan large amounts.

Hard money lenders

Hard money lenders are private investors (an individual or group) that 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.

Hard money loans are useful when speed is of the essence or you don’t fit typical borrowing criteria. However, they’re costly and mostly intended for short-term borrowing, making them a poor choice for people who want a loan that will last for the long term.

Bottom line

Learning 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 different lenders work and how they (and their loans) differ from one another. If you’re ready to start exploring, Bankrate rates lenders based on factors including affordability, availability and customer experience so you can select the best mortgage lender for your situation.