Is it better to go with a big or small mortgage lender?

December 10, 2012

A mortgage is probably the biggest loan a person will receive in their lifetime, often totaling in the hundreds of thousands of dollars and taking ten, twenty, even thirty years to repay. It is understandable, then, that some borrowers might gravitate toward the big, recognizable names: a big name means the company is more dependable in the long run, more likely to still be around in thirty years so you avoid any problems with your mortgage, right?

Most fears about smaller second and third tier mortgage lenders are centered on the idea that a small company is more likely to fail in the timeframe of their mortgage. Some borrowers simply don’t know what would happen in that situation and so want to avoid having to find out. Some might think that they would suddenly have to pay the entire balance of the mortgage as soon as the company goes out of business, or if the mortgage is taken up by another lender, that the contract would be renegotiated and could end up a lot worse.

The reality is a lot more benign. Many smaller lenders are funded by larger financing companies or other investors who usually have a laundry list of regulations and protections that need to be in place before any lender is even in the position to give you a mortgage. One of those is at least one backup option in the event of a company-wide failure: another company who will pick up the mortgage exactly where it left off. Many times, there are multiple back up plans for these kinds of scenarios.

When a backup servicer picks up a mortgage, in all but the most radical of scenarios, they are legally required to uphold the contract made by the original lender. That means all payments continue exactly as if nothing ever changed: the most that might happen is the check must be made out to another company.

Subprime mortgage lenders

There is one major exception to the rule, and that is subprime mortgage lenders, like the kind that led to the global recession. Since they are necessarily dealing with a riskier crowd, the odds of a small subprime lender going under are usually higher (though still pretty low overall). And since it is a less established business model in the first place, there might not be the same protections and backup servicers in place as with a prime lender. In rare occasions, a subprime borrower might not be able to find someone to refinance their mortgage when their initial lender goes under.

The vast majority of second and third tier lenders are what is known as prime lenders, however, meaning they only give mortgages to those with credit ratings above a certain quality threshold. There is often little to no additional risk in dealing with these sorts companies compared to the larger mega-corporations.

The benefits, however, might be more obvious. Since larger companies compete over a much larger region, overhead costs are higher and they are sometimes unable to drill down offers to a very local level. For these reasons and others, smaller lenders might be able to offer you a better rate. On a $250,000 mortgage, a 0.1% reduction in interest rate equates to over $1,200 more in your pocket over five years – definitely worth shopping around for.

That’s not to say the big companies don’t have their own advantages. Branch locations and quantity are a major reason to go with one of the big guys, as well as integration with other financial instruments, credit lines, and online account and payment options that smaller companies might not offer.

Of course, for a lender of any size, it is always important to read the fine print before signing a mortgage contract. Unscrupulous penalties, fees, processing charges, closed terms, refinancing restrictions, and other provisions unfavorable to the customer are just as likely to be on a small lender contract as on any other. Always shop around for the best mortgage rates before deciding on a lender.