A mortgage has become synonymous with home financing, but it’s important to understand there’s not just one type of mortgage. In fact, there are many different lending options at your disposal when it comes time to purchase your home, and a few variables, such as the type of home and your financial situation, can influence whether you should take out a loan from a primary or secondary lender.
The primary market
The primary market is made up of lenders who make loans directly to consumers. Primary lenders keep these loans as part of their portfolio and service them for the life of the loan. So what are some advantages to using a primary lender?
- Primary lenders are locally-based institutions. These are your locally-owned, community banks. They are familiar with the local market and can usually make decisions quickly based on local market conditions and trends.
- Flexibility. Being locally-owned means that you get to deal directly with the decision makers. If your financial situation doesn’t fit within the norm, primary lenders have the flexibility to consider outside-of-the-box solutions.
- Low closing costs. Primary lenders are able to do all of the underwriting and loan documentation in-house. This eliminates most of the fees associated with closing a loan in the secondary market. On a related note, most primary lenders will not require you to escrow your insurance and taxes. This removes the need to put a large deposit in your escrow account at closing.
Loans from primary lenders can be very convenient, and they usually (but not always) include the following features and requirements.
- Primary lenders usually offer an Adjustable Rate Mortgage (ARM) loan. This means that your rate is fixed for a set period, usually 5 years, and then adjusts annually based on a pre-determined index. With ARM products, your payment could change over time (depending on what happens to interest rates). Borrowers need to be aware of the maximum payment they may face during their loan and plan accordingly. There’s almost always a cap for how high the interest rate could go during the lifetime of your loan, and you can use this number to calculate your maximum monthly payment.
- The down payment for primary lenders will usually be at least 10 percent and sometimes as high as 20 percent. Depending on circumstances, you can find a lender that will do less, but to be safe, plan on at least 10 percent.
The secondary market
The secondary market is dominated by players such as Fannie Mae, Freddie Mac, and Ginnie Mae. And no, they’re not all named after family relatives. These institutions will buy mortgages that are originated through mortgage brokers and some of the larger regional and national banks. Since they never see the borrowers or the property before the loan is originated, there are strict guidelines that must be met for them to purchase these loans from the originator. Here’s why you might want to use a mortgage broker:
- Fixed rates. Lenders who sell their mortgages on the secondary market are able to offer long-term fixed rates up to 30 years. While taxes and insurance could cause your payment to rise during the course of the loan, a fixed rate means that the principal and interest portion will remain constant over time.
- Down payment options. Through the secondary market, borrowers have the options of applying for FHA, VA, USDA, FRM, ARM, Balloon or numerous other types of loans and programs offered by the government. Each of these loans has different guidelines in order to qualify. Some borrowers can qualify for loans with little or no down payment.
These features are often the most important to potential home buyers. The security of knowing your payment will never change, coupled with the flexibility to have a low down payment, are attractive selling points.
But, there are a few things to consider before pursuing a loan from a secondary lender.
- Escrow accounts. Most secondary guidelines require you to escrow your insurance and taxes, including a deposit into your escrow account at closing, that will cover six months of property taxes and one year of insurance. This can usually be waived once you have 20 percent equity in your home.
- PMI, or Private Mortgage Insurance. Borrowers with less than 20 percent equity in their home are required to pay PMI on top of their normal payment. PMI generally costs between 0.5 percent and 1.0 percent of the cost of the loan (per year). For a $100,000 loan, expect PMI payments of $750 annually or an extra $62.50 per month.
- Closing costs. In addition to the escrow deposit that is usually required, borrowers will also have to pay closing costs that can include underwriting fees, application fees, doc prep fees, inspection fees, surveys, and possibly more. Primary and secondary lenders are required to disclose a list of fees associated with their mortgage. Applicants should look over these closely and make sure they understand each fee.
Every potential homeowner has their own unique set of circumstances that will dictate which route is best for them. As with most things, being fully informed of all the different options is key to making the right decision.
About the Author:
Matt Smith is a consumer, real estate, and commercial loan officer at Central National Bank. When he’s not making loans, Matt likes to play any and every sport (and promptly injure himself) and spend time with his wife and two children.