First Time Home Buyer Series: Key Differences Between Lenders

In this post we will look at the key differences between lenders, both local and national, as well as how they make money. Learn the best option for your situation.When purchasing my first home, I contacted a number of local and national banks, as well as a mortgage broker.

It was surprising how different groups of lenders loan terms were. If I had gone with the easiest option, it would have cost me thousands of dollars in interest payments. Let’s take a look at how lenders make money, as well as some of the many different lender options.

Key Differences Between Lenders

How Lenders Make Money

There are primarily two main ways in which lenders make money issuing loans. It is these key differences between lenders, both local and national, that impact the strategies they use that reverberate across the way they do business, the fees and interest rates they charge, how they market and much more

Before we compare the types of lending institutions, let’s first broadly understand how lenders make money.

Approach 1 – Underwrite & Hold

In this model, lenders review mortgage applications and loan out funds to home buyers using their own assets. Depending on the reserve requirement (ratio of deposits lenders must keep on hand), lenders are able to lend out multiples of the amount of deposits they have on hand. That’s how new money is “created.”

So if a lender has a large amount of deposits, it can choose to issue a large amount of loans. Of course, there is risk associated with this, so lenders often make many different kinds of loans with differing levels of risk and interest rates to make a “safer” risk adjusted return.

Lenders that take this strategy keep the loans they issue on their books until the maturity of the loan and earn money from the loan origination fees and interest payments.

Approach 2 – Underwrite & Sell

In this model, lenders only hold the loans they issue on their books for a short period of time (1-2 months or less). They then bundle and sell the loans to companies that consolidate them, and often go on to resell them to financial institutions and funds. These bundles of loans are often referred to as Mortgage Backed Securities and were made infamous in the subprime mortgage crisis.

Because lenders only hold onto the loans for a short-period of time, their focus is on how many loans can be generated. They make their money mostly on the origination fees and from selling the loan to a consolidator.

Now that we’ve looked at how lenders generally make money, let’s take a look at the different traditional players in the market.

Types of Lenders

Local Banks and Credit Unions

These companies operate their businesses regionally and often pride themselves on being a part of the communities they operate in. They know the area well, and often hire locals. It is also not uncommon for the same people to have been working for the same company for many years.

Main Pro
– Know the area well, and will likely be able to share more information up front (ex: homes in that area are appraising between $250,000 to $275,000)

Main Con
– May not be able to provide the lowest interest rates or best terms

National Banks

These are large financial institutions like Wells Fargo and Bank of America that you can find in most cities and town across the country. While they still hire locals, they have national policies and different regulations that they have to comply with, which often means a higher cost structure.

Main Pro
– Likely to have more resources at their disposal which may come in handy

Main Con
– Less flexibility and quite often don’t have a loan representative in smaller towns (due to cost cutting measures)

Mortgage Brokers

These companies bring together many different lenders (banks, credit unions, insurance companies etc), and based on your credit score and financial situation, can offer you loans that you wouldn’t otherwise have known about.

Main Pro
– Wide selection of loan options

Main Con
– Fee structure can be a bit confusing at times

Lenders with an Online Presence

Whether it is a regional bank who is looking to add more clients, an online bank or a large national bank, there are many players looking for a piece of the action. Incidentally, for my home loan, I went with a lender of this variety because they offered the most competitive rates, were all e-documents and quick to respond to e-mail.

Not all companies are created equal though, so be sure to check out reviews before you decide to go ahead. I passed on several lenders because they had horrible reviews.

Parting Thought

At the end of the day, money is money. It is a commodity, and whether you get a loan from a large bank or a local one, the seller of your prospective home really doesn’t care. Relationship can be important, but the terms of the loan also have to make sense.

The key difference between lenders really comes down to the terms that they can offer you and their level of service and credibility. I ended up passing on a loan from a local bank where a friend worked because they were just too expensive. The regional bank that I went with was an Underwrite & Sell type institution, and their focus was on volume. That translated into more favorable origination fees and interest rate.

What makes the most sense for you will depend on your situation, and I recommend reviewing all available options to save yourself the most time and money. Also keep

To read more in the First Time Home Buyer Series: