Buying a house is the biggest purchase most people will ever make. So weighing the available options when choosing a mortgage lender can feel overwhelming. And it’s not as simple as choosing between a bank and a credit union.
Typically, lenders are divided into the primary and secondary lending market.
The primary mortgage market is where borrowers can find a lender to finance their mortgage. They usually deal with these lenders directly (or through an intermediary) from pre-approval to closing, as well as for any refinancing throughout the lifetime of their mortgage. Commercial banks, credit unions, and mortgage bankers are some of the main players in the primary mortgage lending market.
The secondary market is where investors can buy and sell debt from pre-existing mortgages. Often, once a mortgage is closed by a primary lender or retailer, it is packaged along with other similar mortgages or real estate loans, and sold as an investment product (the same way a bond is sold), called mortgage backed securities. The biggest companies in the U.S. in the secondary market are Fannie Mae and Freddie Mac.
Most people will only ever interact with primary lenders. The following is a quick guide to the different types of lenders in the housing market.
Direct or Retail Lenders
Direct mortgage lenders are financial institutions (or individuals) that originate their own loans (either with their own funds, or by borrowing from another institution) and deal directly with prospective home buyers. Commercial banks, credit unions, and mortgage bankers are all direct lenders. However, there are many more institutions within this category, many of which operate entirely online.
One of the biggest direct mortgage lenders in the U.S. is an online retailer called Rocket Mortgage, which closed US$351 billion in loans in 2021.
One of the biggest perks of direct lenders is the ability to cut out the middleman. This simplifies communication between lenders and borrowers. However, if a borrower is trying to shop around for the best deal, they will have to submit multiple applications when dealing with separate direct lenders.
Commercial banks are financial institutions that make a profit by offering services like banking accounts, accepting deposits, making loans, and selling other banking products. These institutions are some of the largest providers of mortgages.
In Canada, they include banks like the Royal Bank of Canada and The Bank of Nova Scotia. In the U.S., Wells Fargo and Bank of America are two of the largest commercial banks that provide mortgage financing. People can make an appointment with a bank representative and secure a loan directly with the bank.
Since these banks are heavily regulated, they have some of the toughest lending criteria, which can make it difficult for people with poor credit scores to qualify for a mortgage with a bank. Each bank has a specific set of loan options, offers their customers a limited array of lending options, and charges high fees.
However, banks typically have the lowest interest rates available, which they often offer at a discount. They are also convenient for people who want to do all their banking in one place.
Loans from commercial banks can also be obtained through an intermediary like a mortgage broker. These intermediaries shop around for the best terms and rates with different primary lenders and help facilitate the arrangements for the borrowers.
Unlike commercial banks, credit unions are not-for-profit financial institutions, which provide mortgage financing among their services. In Canada, the largest credit unions include Desjardins, Ontario Credit Union, Steinbach Credit Union, and Prospera Credit Union. Alliant and Bethpage Federal Credit Union are examples of credit unions in the U.S. that provide mortgages.
Credit unions typically have lower fees, lower rates, and give better one-on-one service than banks. Their lending requirements are also typically not as stringent than with larger banks, so people with lower credit have an easier time getting approved.
However, most credit unions have membership requirements that not everyone fulfills. For example, there are credit unions for veterans, or for farmers. Credit unions also don’t typically have as many branches, and many of them don’t offer their services online, so getting access to your institution might be more difficult than with a traditional bank. Lastly, smaller credit unions have a tough time competing with the pricing available at banks, so you might end up paying more in the long run.
Mortgage bankers fund and originate mortgage loans. They are individuals who work for lending entities, banks, credit unions or mortgage companies. On rare occasions, mortgage bankers can also work for themselves. Depending on the case, mortgage bankers use their own funds, or borrow from a warehouse lender or use the bank’s resources to fund the mortgage.
Unlike mortgage brokers, which work as intermediaries between the borrower and the lender, mortgage bankers handle the application, underwriting, and approval of a mortgage loan directly. And unlike brokers, who have a wide range of lenders to pick from, mortgage bankers work for a specific bank, or institution.
Depending on the way that the mortgage banker has their business set up, they can often service the loan throughout its term, but it is common for them to sell the mortgage in the secondary mortgage market, once it has closed.
One of the biggest draws for mortgage bankers is the speed with which they work. Since they represent the financial institution directly, and are involved in the approval process itself, closing tends to happen faster than with a broker. Mortgage bankers also have access to special rates that they can offer pre-existing clients of their bank or institution.
However, since mortgage bankers only work with a specific institution, they don’t have the same ability as brokers to shop around for the best rates and/or terms. Additionally, the loans they offer are more generic, and are not usually tailored to a client’s specific needs.
Portfolio lenders specialize in mortgages, and are also part of the direct lender market. But unlike most retail lenders, they don’t sell their mortgages in the secondary mortgage market once they close. Instead, they keep this debt in their portfolio as an asset.
Since the risk of these mortgages is borne entirely by a single private lender as they’re not prepackaged into mortgage-backed securities and resold to investors, portfolio lenders are able to set their own borrowing requirements.
Each portfolio lender sets their own individual guidelines as to who qualifies for a mortgage and who doesn’t, so these lenders tend to be a good option for people who don’t qualify with traditional lenders, as less strict guidelines facilitate the underwriting process. For this same reason, portfolio lenders can also offer more flexible payment schedules, larger loan amounts, and smaller down payment options.
The biggest drawback of portfolio lenders are higher rates and fees, associated with accepting riskier mortgages. Prepayment fees are also common for portfolio lenders, which can make it very expensive to pay off your mortgage early.
Hard Money Lenders
Typically, hard money lenders are individuals or private businesses within the retail mortgage market, who have large cash reserves.
This type of lender is generally used as a last resort, when prospective borrowers can’t pass a mortgage stress test, or don’t qualify with other types of less risky lenders. Because their fees are so high, they are more willing to lend money to people with bad credit or no credit. Hard money lenders are also appealing for developers who flip houses and plan to repay their debts quickly.
Usually, hard money lenders offer loans that need to be repaid within a few years, and have some of the harshest fees and interest rates (sometimes as high as 20%). Hard money lenders typically require a substantial down payment, and if the borrower defaults on their loan, the property is almost always seized.
Wholesale lenders work exclusively with third party retail lenders, like mortgage brokers, banks, or credit unions. They don’t offer their money directly to individual customers. Some large banks have both retail and wholesale operations, but their divisions cater to very different clients. For example, Bank of America has mortgage bankers that deal with customers directly, but they also offer loans through other financial institutions.
Wholesale lenders make the actual loan, and typically appear on the mortgage documents, but the transaction or deal is brokered through another bank or credit union, for a fee. For the entire process of the mortgage, from pre-approval to closing, the customer deals with the intermediary institution.
Warehouse lenders are similar to wholesale lenders, but they lend the money directly to the institution that is originating the loan, not the customer. They provide short-term funding for intermediaries like mortgage bankers or small mortgage banks. Usually, the loans that warehouse lenders make are short-term. They are repaid as soon as a mortgage closes with the client, and the debt is then sold on the secondary mortgage market.