Why most people don't get mortgages from banks anymore

Nonbank lenders tend to be more flexible with borrowers who have lower credit scores.

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The housing market is continuing its hot streak with mortgage applications surging into the holiday season, a time when demand typically cools off. 

Getting approved for a mortgage loan quickly can make you a more attractive buyer to a homeowner. Nonbank lenders like Rocket Mortgage and LoanDepot are online mortgage providers that can close on loans quicker than traditional banks. Some nonbank lenders can provide mortgage preapprovals in minutes. 

Nonbank lenders are outpacing traditional banks, issuing 68% of all mortgages in 2020. Nonbank lenders specialize in mortgage loans and offer some perks that banks can’t, says Jim Pendergast, senior vice president at altLine, a division of the Southern Bank Company. But there are some tradeoffs to the convenience and advantages offered by nonbank lenders. 

If you’re in the market for a home, here’s what you need to know. 

What are nonbank mortgage lenders? 

They are not not banks and don’t offer banking services like checking or savings accounts. 

For the most part, nonbank lenders exist only online and can approve a mortgage as quickly as eight days. Banks can take anywhere from 30 to 45 days. 

Unlike banks, these lenders can’t use funds in customer accounts to help finance mortgage loans. Instead, they borrow the money on a line of credit, then turn around and lend that money to borrowers. 

However nonbank mortgage lenders do make money off the loans they issue. A nonbank lender can sell your loan to an investor. The lender may earn a loan origination fee, a collection of fees you pay as part of your home closing costs. These are standard fees that you pay to the lender and other third parties when your mortgage is finalized. 

The lender may even sell the mortgage servicing rights to another party, who will perform the customer-facing duties of the mortgage. That can include collecting your monthly payments, holding taxes and insurance premiums in escrow, and providing loan documentation. If your loan or loan servicing rights are sold to another party, it won’t affect your interest rate, fees, or other terms of your mortgage. But it can impact who you’re doing business with or who you’re sending your money to. 

If your loan or loan servicing rights are ever sold, you will be told where to pay your mortgage moving forward. “It’s not uncommon for lenders to sell accounts to agencies to get an immediate payout. Contracts can change hands frequently in the mortgage business, so find out what your nonbank mortgage lender does with your contract after closing,” Pendergast says.

Getting a nonbank loan

One of the biggest advantages of nonbank lenders is convenience. You can submit and manage the entire loan process online, including preapproval and underwriting. Other than that, the loan application process for a nonbank mortgage is very similar to bank mortgages. 

To get prequalified for a loan, you will need to submit information including your name, address, contact information, Social Security number, income, assets, and down payment amount. The lender will perform a credit check and, assuming you meet their standards, provide a preapproval letter that states they are willing to extend a loan up to a certain amount.  

Getting preapproved eases the homebuying process with real estate agents and sellers alike. You can show the preapproval letter to real estate agents to establish you’re a bona fide homebuyer and find homes in your budget. You can also include your preapproval letter in your home offer to show the sellers that you’re a qualified borrower. You may want to tailor your preapproval letter to the exact amount of your offer when you’re ready to move into a home. 

After you make an offer on a house, your mortgage lender will start the underwriting process. Your mortgage application will be reviewed for approval and an interest rate is determined. The underwriter will take a close look at your credit, employment history, income, assets, debt-to-income ratio, and the amount of your mortgage to get the loan approved. You may be required to submit more information than you already provided during the preapproval process, and it is possible that your application could still get denied. 

The lender will also order a home appraisal to make sure the loan amount isn’t greater than the home’s market value. If it is, you will probably either have to reduce your offer amount or make up the difference out of your own pocket to get the purchase to go through. Once the mortgage closes, you will be responsible for the monthly payments, just like any other type of loan. 

Deciding if a nonbank loan is right for you

Nonbank lenders have limited physical locations (if they have face-to-face customer service at all). If you want in-person service, you might not be able to get it through a nonbank lender, and you definitely won’t be able to service your mortgage, checking, and savings accounts all in one place.

Refinancing your mortgage can be easier with a traditional bank loan, but banks tack on fees for compliance. “So, you may think you’re getting a $200,000 loan for a home, but you’re actually agreeing to pay an additional $5,000,” Pendergast says. 

Look for lenders with a good reputation. You can check lender ratings with the Better Business Bureau and the CFPB complaint database for starters. Any lenders you work with should be knowledgeable and forthcoming, and willing to help you with questions about the mortgage process, the loans they offer and any other questions you have. 

Nonbank lenders tend to be more flexible with borrowers who have lower credit scores. For example, Rocket Mortgage will work with borrowers with credit scores as low as 580, or 500 if the borrower can come up with a 10% down payment. For this reason, nonbank lenders issue far more government-backed loans, like FHA and VA loans, that are intended for first time homeowners, lower income borrowers, people without large down payments, and other individuals who are higher risk in the eyes of the lender. Many banks technically offer these loans, but they may not be as willing to approve you if you fit any of those categories. 

If you’re turning to a nonbank lender because you have a lower credit score, low income, or no money for a down payment, you may be more likely to get approved but you’ll still pay higher interest rates than more qualified borrowers would. 

If your credit isn’t in great shape, you may want to work on improving it before you take out a mortgage instead of finding a lender that will accept your existing low credit score. Improving your credit will give you a better shot at loan approval and can help you save money by accessing lower interest rates. 

No matter what type of lenders you’re looking at, it pays to shop around for the best interest rates. A lower interest rate can save you thousands of dollars over the lifetime of the loan, and it costs you nothing to check with at least a few lenders. You can start with your existing bank or credit union to see if you can get a good rate. Just don’t forget to look at closing costs and other fees as well.  

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