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Mortgage Lending 101

So You're Thinking About Buying A Home? Of Pursuing The Glorious American Dream Of Owning Your Own Piece Of Real Estate To Secure Your Family And Future?

Congratulations! Your First Step Is To Obtain A Mortgage Loan...

But With Perplexing Industry Terminology And An Overwhelming Assortment Of Lenders Plying Their Services, How Can You Be Assured That The Vital Choice You Are About To Make Is The Correct One?

Most of us have a basic understanding of how a mortgage works. You determine the amount of money you need to borrow, and submit an application for finance approval. Once the lender approves the loan, the purchase price is released at settlement to the seller in exchange for the keys to the property. You now "own" your own home and your very own mortgage - a regular payment made to the lender over a set term which not only recovers the money you borrowed, but includes interest.

Three categories of lender options

Without getting too complicated, there are three main groups of lenders who finance mortgages. These are mortgage lenders, wholesale lenders and subprime lenders. Each fulfils a specific role, and has its own particular niche, although the three are somewhat interlinked.

Mortgage lenders

A mortgage lender can be defined as any body which lends funds for the purpose of purchasing or securing against a property, but in general terms is taken to mean an organisation, such as a bank, which lends money directly from within its internal structure. Mortgage lenders are often corporations who deal with large amounts of money.

To obtain a loan from a mortgage lender, you are able to deal directly with the lender. This may mean an appointment with your local bank manager, submission of a paper application via mail or fax, or an online application submission.

The majority of loan products offered by mortgage lenders are conforming loans. These are conventional loans which fall within set guidelines aimed at protecting borrowers in the long term from failure to maintain their commitment. The guidelines include such factors as serviceability (the client's ability to maintain the loan repayments based on their income, existing debts and living expenses), credit history and the loan-to-value ratio (the amount you are borrowing in proportion to the overall value of the property).

Wholesale lenders

A wholesale lender is a body which offers funds through the mortgage broker market. The wholesale lender is often also a mortgage lender (I know it sounds confusing, but stay with me.) As the name implies, the lender offers 'wholesale' loans, often with reduced rates or discounts on its normal 'retail' products purchased over the counter e.g. in the bank. Put simply, the mortgage lender is paying a broker, through its wholesale arm, to do all the hard work of finding them clients. In effect, the mortgage lender has an army of representatives on the ground actively collecting clients for its products, as opposed to waiting for them to walk into a branch.

To obtain a mortgage from a wholesale lender, you will deal with an independent mortgage broker. A mortgage broker usually represents many different wholesale lenders, and as such should be placed to offer an unbiased overview of a range of different loan products and features. The broker is normally paid a fee for bringing the client to the lender.

Wholesale lenders predominantly offer conventional or conforming loans.

Subprime lenders

Subprime lenders are financial institutions that lend funds to people who generally do not fit the conforming criteria for conventional loans. Subprime loans are offered at a higher risk to the lender, as clients who generally pursue this type of finance have often exhausted standard avenues of obtaining a loan.

Sub-prime borrowers often have low credit scores, default listings, bankruptcies, a history of late or missed payments on previous loans, credit cards or bills or too many debts. Conversely, those with a limited debt history, that is, they have not been approved for lending in the past so have no substantial evidence of having been able to successfully repay a debt, also often fall into this category.

To counteract the risks associated with lending to people who present a greater potential to fail on the loan, subprime lenders offer products that are substantially higher in interest. There are also sizeable fees applied for defaults and late payments, and often other associated charges such as annual fees.

Many borrowers turn to subprime lending options for assistance in consolidating debts, or to give them a start in purchasing their own home. It is undoubtedly a more costly option, but offers an opportunity for financial advancement when conventional lending says 'no'.

So what is the best option for me?

Buying your family home is possibly the biggest investment and certainly one of the most important decisions you will ever make in your lifetime. Of course, there are many variables involved. There's 'location, location' - where will you decide to lay your roots? How much are you prepared to spend? What style of home do you prefer? Should you buy a new or an established home, or should you build instead?

Certainly one of these vital decisions involves your choice of lender. By now you should have a better understanding of the various sources for obtaining your mortgage. Each group has its own particular benefits, and some of these are subjective depending on your individual values and requirements.

The Mortgage Lender option

Let's discuss obtaining your home loan from a traditional mortgage lender; we'll call them ABC Bank. Perhaps you have been a customer of ABC Bank for many years. You are comfortable with entering your local branch, the staff is friendly and welcoming and you feel that you are looked after. You believe they have your best interests at heart.

Perhaps over the years, you have been to ABC for different services. They may have assisted you with a range of savings and checking accounts, or offered advice on smart investing to secure your finances for the future. This trust and rapport is one reason that clients seek to obtain their home mortgage from their banking lender.

The first step is to determine the various loan products on offer. The lender will have a limited range, but there may be a product that suits your requirements. Interest rates are generally competitive with other mortgage lenders.

Another alternative is to shop around and visit other lending organizations. Most institutions will be happy to extend their services even if you are not a current customer.

The Wholesale Lender (or mortgage broker) option

Wholesale lenders offer their loan products to the consumer through a mortgage broker.

A broker is accredited with a variety of lenders, and has a wide product range (numbering even in the hundreds) to offer you. The broker will be able to present several different products to suit your particular requirements. One of these may even be a loan from ABC Bank; the product may be similar to a loan offered in their branch, but will often include some kind of discount or even a reduced interest rate. Having said this, you may find that not all products are cheaper or 'better' than those offered by a mortgage lender, but you will a greater variety of options.

If you enjoy having a spectrum of choices, dealing with a mortgage broker to obtain a wholesale product may be the right choice for you.

The Subprime Lender option

If you believe that you are unlikely to meet the requirements necessary to obtain a conventional loan from a traditional institution, the subprime lending option may suit you.

You should carefully weigh up the benefits with the associated (higher) costs involved. People often pursue this option to help get back onto their financial feet and consolidate existing unmanageable debt, or as a final avenue of access into the home buyer market. If you are able to cope with the higher costs and build a good repayment history over the couple of years, a conventional lender should then be willing to accept your business and refinance the loan at a substantially lower interest rate.

Whether you obtain your finance directly through a mortgage lender, from a wholesale lender via a broker, or through a subprime lender to help you when others can't, you are about to embark on an exciting journey. Take your time and make a choice that you are comfortable with!