People shopping for a home and a mortgage may have heard the term "Portfolio Lender," and wondered at its meaning. In some cases, a borrower who does not qualify for a conventional loan program via Fannie Mae or Freddie Mac is told to seek out a portfolio loan from a portfolio lender.
A portfolio loan is one that is retained for a lender’s own investment portfolio (mortgage inventory) rather than one being sold on the secondary market. This is usually due to the fact that the loan does not conform to traditional underwriting guidelines such as those issued by Freddie Mac or Fannie Mae.
Portfolio lenders, loosely defined, are those who make mortgage loans without the express intention of selling them—either immediately or at some time during the term. Banks, credit unions and savings & loans are the most common portfolio lenders in the mortgage industry, but the line between who and what constitutes a portfolio lender is often blurred because most also operate as mortgage bankers and sometimes brokers. Then too, there are lenders that will keep a portion of their loans as portfolio loans and sell the rest to recoup money to continue to lend. The percentage of the loans they keep depends on the investor involved and how much funding they have. There are also some lenders that are not considered traditional portfolio lenders, but do have some programs that are portfolio only programs. Those who lend money from their own portfolios and hold on to the mortgage are relatively few in number, these days.
Simply put, when lenders hold and service their own loans, they have the ability to work "outside the box" and approve exceptions that typical lenders would not. Though most portfolio lenders tend to follow Fannie Mae and Freddie Mac guidelines they are free to grant exceptions to the norm. For this reason they have often been called the lenders of "second resort".
The term "portfolio" doesn't mean anything inferior. Nor is it where the "credit challenged" go to get a home loan. But, because they have more leeway than larger, stockholder-driven institutions, they can make lending decisions based on the intangibles as well as the tangibles of a transaction. This flexibility can often mean that a portfolio lending underwriter can be more liberal when evaluating things such as past credit problems, prior bankruptcies, lack of cash reserves, etc. Therefore, it is often easier to qualify for a portfolio loan than for a loan which is being sold to a secondary investor.
At the same time, borne out by their plan to hang on to the loan for the long term, some portfolio lenders can be more restrictive in other regards like the types of properties they lend on (owner occupied as opposed to investment), loan to value (LTV) ratios, appraisals and review, since, in the event they have to foreclose, they need to make sure that the property will resell, quickly, and for at least what they lent on the property. Consequently, portfolio lenders cannot be reckless in granting loans or they would not be in business very long.
In all matters economic, there is a risk/reward ratio—the higher the risk, the higher reward. Portfolio loans typically have higher rates for three primary reasons: 1) the underwriting terms are often more liberal 2) because portfolio loans are not marketable to Wall St. via the secondary market they are intrinsically riskier propositions and 3) term risk, since lenders have to hold them in their portfolio for the entire loan term.
When Portfolio Lending Makes Sense
Anytime one’s proposed loan or financial situation doesn’t qualify for conventional underwriting is the time to consider a portfolio product. What follows are a few examples of when portfolio lending makes sense:
TIMING. Let's say that a 4 unit investment property comes on the market both at the right time and at the wrong time. At the right time, because the price is well below market, but at the wrong time because you can't come up with the money fast enough for the down payment. If you went to a conventional lender, the down payment requirement could be as high as 25% of the purchase price. And you may not exactly have that kind of money on hand.
DEBT RATIOS. Perhaps, you want to build not just one, but two houses at the same time: One for you, and one for a rental. But your ratios won't let you do both, and without loan approval for the permanent mortgage you also find you can't get construction funds. Again, check into portfolio products.
FINANCIAL SETBACKS. One more example might be someone whose credit rating suffered while out of work for an extended period, but who is back on track. Or, a savings & loan might be more concerned with an individual's savings history than being able to fully document their income.
HISTORY. In the past, portfolio loans were issued by banks or thrifts that were more than happy to make loans that just did not quite "fit" the conventional mold yet made good sense from a financial perspective. If one already had a relationship with that bank, the bank was more inclined to evaluate a loan based upon things other than down payment and debt ratios.
NICHES. Portfolio lenders also have "niche" products. Some offer excellent jumbo loan rates, non-income verification loans, loan programs for foreign nationals, and loans not based solely on a FICO score, although the borrowers use of other credit and past credit history is a determining factor in any loan program.
MORAL GOOD. They can and will go somewhat beyond the guidelines for a good reason. One example is making loans to low-income buyers to help them achieve home ownership. This action is a decision that is good for the community as well as for the homebuyer.
Aside from cost and underwriting guidelines, the only other major difference with a portfolio loan is the borrower does not have to change where he sends his payment because his loan will not be sold multiple times over the life of the loan. Even so, in today’s modern world one can pay one’s bill online even if the mortgage is sold to a loan servicer.
THE SECONDARY MARKET vs. PORTFOLIO LENDING—EXPLICATED
To more completely understand the portfolio lending concept and its implications for consumers, it is helpful to understand how the Secondary Market functions. One might ask: How can a bank sell a mortgage? Why would a bank make a mortgage loan, only to sell it? Who would buy mortgages, and why?
Investors who buy the mortgages originated by others make up what is known as the secondary mortgage market. For residential mortgages, the largest investors in mortgages are two quasi-governmental institutions: the Federal National Mortgage Association (popularly known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (popularly known as Freddie Mac).
These organizations buy large numbers of loans from banks and other mortgage originators and then re-package the loans in groups of similar type loans to be sold again as what are known as mortgage backed securities. These securities are traded like stocks and bonds.
Because they buy so many mortgage loans from original lenders, and because they desire to limit risk for buyers of their mortgage-backed securities, Fannie Mae and Freddie Mac have developed market standard guidelines for the loans they will be willing to buy. The guidelines include such particulars as the percentage of total income that is allowable for a borrower to spend on mortgage payments and total debt service, maximum loan amounts, down payment sources, and other particulars. Lenders that wish to sell mortgages to Fannie Mae and Freddie Mac must make loans that conform to these strictly enforced underwriting guidelines.
Mortgages are considered business investments. In mortgages, as in other investments, there are anticipated returns on investment (the interest paid over the life of the loan) and degrees of risk (the possibility that the interest and/or the principal will not be repaid). Like other investments, mortgages-with their potential risks and rewards-can be sold by one investor to another. To offer an investor an adequate return on a mortgage that was made at market interest rates, the mortgage originator may have to sell the loan at a discount. For true portfolio lenders, mortgages are also investments in customers and in the communities served, allowing for growth and helping to maintain a healthy social and business environment.
As we have seen, banks and other mortgage lending institutions comprise the investment base. They allocate a percentage of their total assets to mortgage loans based on what is prudent to maintain a balanced portfolio. If, at a given time, they feel they have too great a percentage of assets invested in mortgage loans, they may decide to sell some of the loans to other investors. This is a way to hedge risk and to increase liquidity.
Many institutions use the funds received from selling mortgage loans to make further mortgage loans. This can be beneficial to a community that needs a larger pool of mortgage funds at a particular time than it can generate from bank deposits or other sources.
On the other hand, a lender may want to increase its overall percentage of assets allocated to mortgages and then hold them in its investment portfolio in order to realize the full value of the investment. Some portfolio lenders hold mortgages because it is important to build a solid, long-term relationship with borrowers through the process of servicing the mortgage over the years.
Mortgage lending has two parts: loan origination and loan servicing. Origination involves all of the steps from application through making the loan. Servicing involves accepting and allocating mortgage payments and handling any correspondence or problems that may arise over the life of the loan.
It is important for borrowers to know a bank’s intentions with respect to the disposition of its mortgages because their involvement with the lender does not end when they close on a loan. Therefore, within three days of taking an application for a mortgage, the lender is required by federal law to give the applicant a servicing disclosure that reveals its track record of selling mortgages it originates, including a three-year history, and whether its intention for the mortgage in application is to be sold, or to be held in its portfolio.
When a lender sells a mortgage, it can sell the mortgage and the servicing, in which case the consumer would be notified to make mortgage payments to the new owner of the mortgage. However, if a lender sells the mortgage, but retains the servicing, the consumer may never know the loan has been sold—until a problem arises.
Take the example of a borrower who is downsized out of a job. He or she might call the banker who handled their mortgage loan and has been receiving their on-time payments ever since to request some short term relief, like paying interest only for awhile. Imagine how unpleasant when the borrower learns the mortgage has been sold and such a decision will be made not by the friendly banker who knows them but by some unknown investor. It is unlikely that the borrower would get the temporary relief requested and could end up in foreclosure.
Lenders make money making loans. If they don't make loans, they won' be lenders very long. But now, there are lenders who can offer a variety of loan programs that fit their own specific lending requirements, not just banks and thrifts.
TIPS REGARDING PORTFOLIO LOANS
Using a broker is a definite advantage because they can look at portfolio loans and non portfolio loans to find you the best deal along with the product you are looking for. If you apply for a loan with a particular lender and you are declined, that's it! You're toast! If you wish to pursue a loan you get to start all over from square one. With a broker they can save you time and energy by simply submitting your file to another lender.
Copyright © 2020 Rod Haase. All rights reserved.