One particularly important decision homebuyers face is how to finance their new home. The key? Landing a low-interest loan with minimal fees.
So, how do you do that?
Say a colleague just bought a new condo and scored an awesome rate on his loan. He swears it’s all thanks to the hard work of his mortgage broker. But your friend, who recently invested in her first single-family home says no way! It’s a DIY world, and she secured her loan (with an equally awesome rate) by going direct through her bank.
Decisions, decisions. What are you, a prospective homebuyer, to do?
Lynn Devine, a five-star-rated loan officer with Fairway Independent Mortgage Companies Kansas branch suggests borrowers first consider their credit score, because it’s one of the biggest pre-approval factors and can sway this decision (more on that below).
Next, before deciding on a mortgage broker vs lender, it’s important to understand the difference between the two and to weigh the advantages and disadvantages of working with each.
Luckily, you’ve come to the right place. In this guide, we’re covering all that plus more, along with sharing expert advice that will help you navigate this important financial decision.
What is a mortgage broker?
A mortgage broker is a liaison that helps coordinate a loan between a lending institution and a prospective borrower.
Brokers don’t provide or lend any funds themselves, but use their expertise and resources to connect buyers to lending institutions offering loans that meet their specific needs. Since brokers work with multiple lenders, they can bring forth numerous quotes so buyers can easily choose between loans with different rates.
To do this, mortgage brokers collect required documentation from prospective buyers. This can include bank statements, credit reports, property appraisals, income verification, tax returns, assets, and liabilities. Then the brokers submit this information on a buyer’s behalf. Lenders then use this info to weigh the financial profile of an applicant for approval.
For their service, brokers charge what’s known as a mortgage broker fee, averaging 1% to 2% of an approved loan amount (before interest). For example, a $400,000 loan at a 1% broker’s fee will result in a $4,000 broker commission.
This commission is most often paid after the loan is settled by the lender through what’s known as lender-paid compensation (i.e. finders fee or success fee). The amount can vary from one lender to the next, so it’s possible a broker could make a higher commission with certain lenders.
A broker can also be paid by the borrower through an agreed-upon borrower-paid compensation plan. The key difference here is that lender-paid compensation often doesn’t result in any out-of-pocket costs at closing, where borrower-paid compensation does.
What is a mortgage lender?
A mortgage lender, otherwise known as a direct lender, is any financial institution (i.e. a bank, credit union, or business like HomeLight Home Loans) that offers direct funding to a borrower for a home purchase.
Lisa Mathena, a real estate agent and top producer with nearly 30 years of experience working with mortgage specialists and selling homes in Delaware’s Southern New Castle, Kent, and Sussex counties, notes that buyers with streamlined requirements and strong credit scores might save money by going through a lender.
When a buyer goes directly to a mortgage lender, there is no middle person. The financial institution and borrower settle all financial paperwork and loan agreements directly. With no middle person, it’s up to the borrower to research and approach potential lenders that fit their needs, along with filling out any necessary paperwork.
Lenders will generally cover their costs by charging borrowers a loan origination fee, which is generally 1% to 2% of the total loan amount. This fee is either paid at closing or included in the total loan amount and paid with future mortgage payments.
The primary way mortgage lenders make money is through either collecting interest on a loan’s principal balance (the “principal balance” is the total amount borrowed, while “interest” is the additional amount charged by the lender as the cost for borrowing their money, usually expressed as a percentage of the principal balance) or selling the loan on the secondary market to another bank or investor.
A note about lenders, brokers, and no-closing-cost loans
Another common option that allows a borrower to potentially save on upfront costs – but will cost a bit more over the life of the loan – is the no-closing-cost loan. These loans work in one of two ways:
- The lender adds all closing costs to the total loan balance, which increases the monthly payment of the loan.
- The lender absorbs the closing costs for the buyer, but generally this raises the loan’s interest rate.
Mathena warns that not all no-closing-cost loans (or their interest rates) are the same.
“If you go through a broker, their no-closing-cost loan may be very different from a typical lender,” she says.
For example, Mathena explains how with a USDA loan – which is 100% financed and allows the seller to contribute up to 6% of the loan amount toward the buyer’s closing costs – a borrower could potentially move into a house without any money out of pocket and a (currently standard) 3% interest rate.
But if a buyer who doesn’t qualify for a USDA loan went to a mortgage broker looking for a loan option with no out-of-pocket costs, they may get a similar deal with a conventional loan… but may be facing a significantly higher interest rate once closing costs and fees (such as your broker’s origination fee) are figured in.
“So, you may not be paying the funds upfront, but you’re paying them monthly through the life of the loan,” explains Mathena. “And many times (with government loans especially) you can’t refinance out of those loans for X number of years.”
Pros of mortgage brokers
Brokers are mortgage experts who work with many different lenders, and they usually know where to go to get specialized loans for borrowers who don’t qualify for conventional loans.
But if you already have a strong relationship with a direct lender, is a mortgage broker’s services beneficial for you?
Offers from multiple lenders
With direct lenders, buyers approach one lender at a time with their preliminary information. However, brokers take the borrower’s information and reach out to multiple lenders in one sweep to pull in several loan offers at different terms and rates. This gives borrowers a variety of mortgage options to choose from, making it easy to compare.
Lower borrowing cost
Mortgage brokers may qualify for special fee reductions or “wholesale rates” on loans that borrowers don’t have access to on their own. In addition to these special fees, brokers often have long-standing relationships with lenders and may be able to negotiate more attractive closing costs, fees, and interest rates.
A good option for flexible lending
Worried about a low credit score or need a low- or no-down-payment option? A mortgage broker may be able to help. Most brokers know which lending institutions are more likely to offer special loans to candidates facing financial challenges.
Flexible profit margins
Unlike lenders, mortgage brokers may be open to negotiating their profit margins. That may mean a lower cost to you.
Cons of mortgage brokers
May be partial to lenders
Some brokers may be partial to certain lenders or banks if they stand to make a larger origination fee by working with that institution. Also, a broker may not have access to all lenders or banks because not all work with brokers, so what a broker presents as the best rate may not necessarily be the best rate.
The complexity of a loan and the current housing market in your area may impact how much a broker charges. To avoid any unpleasant surprises at closing, be sure to discuss fee expectations ahead of time.
Brokers pretty much run the show. They choose and approach lenders, and negotiate terms on your behalf. Consider this if you’re more of the hands-on type.
Could prolong the closing process
Dealing with a deadline? Unlike with a lender who handles all parts of a loan in-house directly, a broker has to submit your application to the lender for underwriting and funding, and once they submit the file, they no longer have control over the process, which could potentially delay closing if things get hung up.
Also, though a broker helps navigate you through the loan application process after their work is complete the lender then becomes the main point of contact on the loan. The broker is still available and can be contacted for things like refinancing, but most communication will be handled directly with the lender until your loan closes.
Pros of mortgage lenders
Working directly with a mortgage lender keeps you keyed in during every step of the loan financing process. But is the time and energy you’ll spend worth forgoing a broker who can manage the process (and paperwork) for you?
If your credit is in good standing, your loan requirements are straightforward, your paperwork is in order, and you already have a mortgage lender in mind, then going directly to a lender may be more time and cost-efficient.
Did you say ‘deal?’
Maybe you’ve partnered with your bank on loans in the past and you already have a good partnership going. Because of your friendly terms, your bank may offer special rates on your next loan request to keep you as a loyal customer.
You get to choose the lending institutions you want to apply with, and once you’ve settled in with a lender you’ll work with them, and only them, through the entire loan process. This means you’ll have a single point of contact for any questions, and since all parts of your loan remain under one roof, it may be easier to get answers quicker.
Working with a lender could save you time and money. Mathena notes that fees and rates may be lower with a lender. Closing times are also often shorter.
Also, no broker? No broker fees.
Cons of mortgage lenders
More work for you
When you work with a mortgage lender, you’ll be doing all the legwork yourself, like researching potential lenders, filling out paperwork, and submitting applications. Sometimes multiple applications.
Going to your bank or credit union for a loan might not be an available option since some lenders only work directly with brokers. Additionally, a broker with access to several types of lenders and home loan companies may be able to present more choices.
“A lot of times going through some of the credit unions and banks, they may not have all of the programs that the mortgage companies have to offer. It really just all depends,” advises Devine.
Even after shopping around, you may miss out on a great loan at a special rate. This could be because you didn’t know it was an option because, well, you’re not a broker.
How to decide?
Still debating which is the right choice for you in the mortgage broker vs lender debate? Start by asking family and friends for referrals, or searching online reviews for highly rated professionals.
Buyers can also turn to their real estate agent as a top resource since many agents typically know loan specialists with soundtrack records.
- What fees should you expect?
- How will the fees affect your loan or closing costs?
- What loan options are available to you?
- How long will the loan process take?
- Are there any concerns regarding your application?
- Do you qualify for special interest rates or government programs?
When you find a promising candidate, make sure they’re in good standing and licensed in your area.
Regardless of your decision on mortgage broker vs lender, homebuyers should always shop around and compare offers to ensure the best deal.
“Each product is individual for each customer,” explains Devine. “If you try a mortgage lender and it doesn’t work out, then seek somewhere else to see if there are other products out there for a first-time homebuyer.”
As for some final words of wisdom?
“APR, APR, APR. I can’t stress that enough,” advises Mathena. “Always look at the APR of the rate you’re getting quoted because the APR not only includes the rate but it also includes the fees.”
The APR rate is an overall view of the total cost of a loan presented in one large number. It’s often higher than the interest rate because it rolls together all the costs associated with borrowing a loan, including interest rate and fees. Although, keep in mind that what costs are all included in APR varies by lender.
To help get a better big picture view of the total cost of a loan, it’s always best to compare the APR rate and the loan’s fees to see which costs more in the end.
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