Image courtesy of Flickr, By 401kcalculator.org
Learn the differences between banks and nonbank lenders to help you decide which way to go when taking out a mortgage or a small business loan.
If you were a fan of ''The Sopranos'' or ''The Godfather,'' when you hear the term ''nonbank lender,'' you might have visions of someone coming around to break your legs if you don't pay up.
However, when we refer to nonbank lenders, we're simply talking about financial institutions that don't have a full banking license, that don't take deposits, and that are not a government authorized institution as banks are. Instead of getting funding from deposits, nonbank lenders get it from banks or investors.
Many people are bypassing banks these days and are getting a mortgage or a business loan through a nonbank lender. In fact, the breakdown is about 50-50 on whether people use a bank or nonbank lender. Some sources figure that nonbank lenders are actually writing more mortgages than banks and credit unions are. Lets explore five key differences between banks and nonbank lenders to help you decide where to go to get your loan.
Banks: Ever since the housing crisis of 2008, banks have shied away from mortgage loans. The aftermath of the mortgage disaster for banks included lawsuits, fines, and increased federal regulations. As a result, banks still offer mortgages, but they typically approve mortgage loans to only the lowest-risk borrowers.
''Banks are limited to both the mortgage industry guidelines, such as those set forth by Fannie Mae (FNMA), Freddie Mac (FHLMC), and Ginnie Mae (GNMA), as well as their own internal policies that govern risk,'' says Anthony Piccone, president and CEO of 7th Level Mortgage, a New Jersey based mortgage company. ''Generically these policies are called ‘overlays,' as the bank overlays their underwriting criteria on top of the agencies' guidelines. Overlays, for the most part, place additional restrictions on the loan criteria in order to reduce risk, thus making it more difficult for borrowers to qualify.''
Borrowers that banks tend to lend to now are often affluent and take out jumbo mortgages, mortgages over $417,000 in most states or over $625,500 in high-cost areas. Banks are also getting away from offering FHA loans since the market for them consists largely of people who don't qualify for a conventional loan.
Nonbank lenders: People with average credit still want mortgages, however, so nonbank lenders are often the solution. These institutions can be large and found online or can be local, sometimes even family run, businesses. Nonbank lenders tend to offer FHA loans. ''This can be extremely useful for people who often find it harder to achieve bank funding,'' says Joshua Eke of Factor Funding Co., a small-business funding service.
You might be thinking that alternative lenders were a big part of the mortgage crisis by lending to people who couldn't really afford the loan. And if you are thinking that, you would be correct. However, many nonbank lenders have eliminated the risky features of those loans. If you do run across a lender that offers interest-only mortgages, mortgages with balloon payments, or mortgages with no documents required—all risky features—you should probably keep looking.
Banks: It takes banks, on average, longer to approve your mortgage loan than it takes nonbank lenders. Both banks and nonbank lenders need to gather documents, such as tax returns, bank statements, and more. And after the approval, both banks and nonbank lenders order an appraisal and put your loan package through underwriting after you've signed a purchase agreement for a home. However, the preapproval process takes longer with banks.
Nonbank lenders: ''Outside lenders often have a shorter approval process,'' says Eke. Nonbanks can typically preapprove you for a loan quickly, often in just a matter of days (or hours!). They do this by using automated algorithms for making decisions and by gathering and processing documents electronically. For example, nonbank lenders often automatically import your financial data, which speeds the process.
Banks: Regarding mortgage loans, banks typically require a 20 percent down payment. ''If you go to your local community bank for a purchase loan, and they do not sell off to the secondary market, you are absolutely forced to put 20 percent down as a down payment,'' says Piccone.
Nonbank lenders: Most FHA loans, where borrowers can put down as little as 3 or 3.5 percent down as a down payment, are mainly offered at nonbank lenders. These lenders are typically more flexible with borrowers.
Banks: Banks typically aren't very flexible regarding rates. ''A traditional bank offers one-size-fits-all for rates, fees, etc.,'' says Piccone. ''They are mostly limited in what they can offer in terms of being able to negotiate or deviate from their published pricing.''
Nonbank lenders: Nonbank lenders have more flexibility regarding rates and fees. ''Nonbank lenders are subject to far less restrictions in underwriting criteria and can be more judicious in placing overlays for underwriting,'' says Piccone. He explains that nonbank lenders need to follow the guidelines set forth by the agencies. But they can also be more flexible in the loan types and options they offer.
Banks: Banks are involved in many types of financial services: checking, savings, money market, and retirement accounts; credit cards; and auto, commercial, small business, and mortgage loans. This makes them generalists in the financial sector. ''Because they are generalists, they are limited as to what they can offer for residential mortgages,'' says Piccone.
Nonbank lenders: Nonbank lenders typically specialize in a product, such as mortgage loans or small business loans. ''Nonbank lenders are specialists and are, therefore, quicker, cheaper, more responsive, and in most cases, more knowledgeable than your regular bank loan officer,'' says Piccone.
Credit unions are another option for getting a loan. A credit union is neither a bank nor a nonbank lender. Credit unions are not-for-profit financial cooperatives that exist to serve their members. They function more like banks than nonbank lenders do since they offer a wide array of financial products. But they differ from banks in that banks are for-profit corporations that answer to stockholders and have a paid group of directors that lead their operations. If you belong to a credit union, check it out. You might be able to get a lower interest or pay fewer fees when you get a loan through one.
Whatever you choose to do when getting a loan, shop around with different lenders to get the best deal for you. Check your credit report before applying for a loan. You want your score to be a high as possible before you apply. Then, find out how much you qualify for and the loan terms, such as rates and fees. Compare this information with a couple of other lenders. Note that you should always receive a loan estimate and a closing cost disclosure form whenever you take out a mortgage loan. It's required by law.
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