What Are Portfolio Loans And How Do They Work?
When you take out a conventional loan to buy a home, the lender usually sells your mortgage to a government-sponsored enterprise such as Fannie Mae or Freddie Mac. Portfolio loans are loans the lender keeps on its own books and does not sell. This means portfolio loan lenders are free to set any terms they like, which can come in handy for borrowers who need to customize a loan in some way to meet either their finances or something unusual about the property.
Key Takeaways:
- A portfolio loan is a mortgage that lenders keep on their own books instead of selling to Fannie Mae or Freddie Mac. This allows them to offer flexible terms compared with conventional loans.
- Good candidates for a portfolio loan include those with low credit scores, high debt-to-income ratios or credit history issues, and the self-employed, or cases when the purchase price surpasses normal loan limits.
- Disadvantages include possibly higher interest rates and fees.
What Is A Portfolio Loan?
A portfolio loan is a mortgage that a lender decides to keep on its books as an investment asset. Since the lender doesn’t plan to sell the loan on the secondary market, it is free to set any and all terms for the loan. Portfolio loans are helpful for borrowers with unusual finances that prevent them from qualifying for a conventional loan or borrowers who wish to buy an unusual or extremely expensive property.
“Portfolio lenders take on more risk for potentially higher returns, while qualified borrowers benefit from customized loan terms,” says Dennis Shirshikov, a professor of finance at City University of New York Queens College.
Conventional loans conform to federal standards that limit how much you can borrow. It also requires borrowers to meet financial requirements, including a minimum credit score, a maximum debt-to-income ratio and a minimum down payment. Lenders can sell loans that conform to those requirements to Fannie Mae or Freddie Mac, which package those loans into mortgage-backed securities sold to investors. The lender, meanwhile, can use the proceeds from selling the loan to fund additional mortgages.
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How Do Portfolio Loans Work?
Portfolio loans are similar to conventional loans. As with a conventional loan, the borrower applies for a portfolio loan, and a participating lender evaluates their eligibility and decides on the loan terms and amount.
Since the lender is free to set its own criteria, borrowers might find the approval process more flexible. However, portfolio loans often charge higher interest rates and fees because the lender is taking more risk and has more control over the terms.
Minimum Down Payment
Because lenders can set the terms and are taking more risk, portfolio loans may require a larger down payment than conventional loans – often 20% of the purchase price or more.
Minimum Credit Score
The minimum credit score required to qualify for a portfolio loan varies from lender to lender, although many prefer a score of at least 620 to 680.
Maximum DTI Ratio
Portfolio lenders may allow a higher DTI ratio than required for a conventional loan. Some will allow a DTI ratio of up to 48%.
Closing Costs
Closing costs usually range between 2% and 5% of the purchase price. However, closing costs and fees on a portfolio loan are typically higher than those on a conventional loan.
Other Fees
A portfolio loan may have other fees, including origination fees and prepayment penalties. Again, every lender can charge different fees. A portfolio loan origination fee is often no more than 5% of your loan amount.
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How Are Portfolio Loans Different From Traditional Mortgages?
The main difference between portfolio and traditional loans is who holds the loan after origination. Conventional loans that conform to federal guidelines are sold to Freddie Mac or Fannie Mae. Portfolio loans, on the other hand, remain with the originating lender. This lets lenders offer more flexible terms, but these loans often come with higher interest rates and fees because the lender is taking on more risk.
“The qualification criteria for portfolio loans are different,” says Steven Kibbel, a Certified Financial Planner with Prop Firm App in Franklin, Tennessee. “Since portfolio lenders set their own guidelines, they may consider borrowers who don’t meet the strict standards for conventional loans, such as the self-employed or those with unique income streams. However, minimum credit scores, down payment amounts and debt-to-income ratio limits still apply and may be stricter.”
Additionally, portfolio loans can be used to buy properties that defy the conventional loan mold, including non-warrantable condos, mixed-use buildings or extremely high-value homes. Even so, the lender may have its own restrictions on whether you can buy land, manufactured homes and other properties.
“Also, portfolio lenders can offer payment structures that are more customizable than conventional loans, such as providing longer fixed-rate periods or interest-only options,” Kibbel says. “However, fewer lenders offer portfolio loans.”
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Who Is A Good Candidate For A Portfolio Loan?
Worthy prospects for portfolio loans include borrowers with complex income or credit histories, including the self-employed and borrowers with nontraditional income, such as freelancers, says Jonathan Feniak, general counsel at LLC Attorney based in San Juan, Puerto Rico. “Also, real estate investors seeking more flexible or creative financing options could find a portfolio loan beneficial,” he says.
An ideal portfolio loan candidate is someone with a special relationship with a trusted bank, says Bruce Ailion, a Realtor and attorney in Alpharetta, Georgia. “These may be business owners and professionals who have substantial deposits with the bank but do not qualify for loans that can be sold in the secondary market,” he says.
Pros And Cons Of Portfolio Loans
As with any type of financing, portfolio loans have advantages and disadvantages.
Pros
On the plus side, portfolio loans offer:
- Flexibility in underwriting and loan terms
- Greater opportunity for negotiating terms, fees and rates
- Ability to finance unique or non-conforming properties
- Opportunity for borrowers with nontraditional income to qualify
- Faster approval because the lender will retain the loan and provide its own underwriting
- Potential for customized loan structures to meet specific needs
- Customized service, as the lender maintains an ongoing relationship throughout the loan term
Cons
On the downside, portfolio loans may come with:
- Higher interest rates, closing costs and fees versus conventional loans
- Larger down payment requirements, often 20% or more
- Limited availability, as not all lenders offer portfolio loans
- Increased lender risk, which could result in stricter requirements or higher costs
- Possibly fewer consumer protections compared with conventional or government loans
Choosing A Portfolio Lender
It may be challenging to find a portfolio loan. That’s because many traditional banks and lenders don’t have the resources to hold these loans in-house and, therefore, don’t offer them. “Mostly, it’s community banks, credit unions and specialty nonbank lenders that provide portfolio loans,” Kibbel says. “You’ll need to shop around.”
These institutions have more flexibility in their lending practices “because they are not bound by the strict guidelines required for loans intended for the secondary market,” Shirshikov says.
How To Get A Portfolio Loan
Ready to pursue a portfolio loan? Here’s what you’ll need to do, step-by-step.
1. Find A Lender
Search online for lenders that offer portfolio loans. Again, you may have better luck looking at smaller banks, credit unions and private lenders. Shop around, and compare rates and terms carefully.
2. Meet The Requirements
Ask the lender what is needed to qualify for a portfolio loan, including the minimum credit score and down payment, and the maximum DTI ratio.
3. Apply For A Portfolio Loan
Once you’ve chosen a lender, you formally apply for the loan. Be prepared to document your finances by providing tax returns, bank statements and proof of assets. Also, expect to provide detailed personal information and financial details about your property, savings, holdings and more.
4. Await Approval
The lender will examine your application, considering both traditional and nontraditional factors. Expect underwriting to take a few days to a few weeks.
5. Close On The Loan
Once approved, you’ll proceed to closing, signing the final loan documents and paying your down payment and closing costs.
FAQ
Here are answers to common questions about portfolio loans:
The Bottom Line
Need to borrow significant funds but having trouble finding a willing lender? Consider a portfolio loan, which can provide convenient financing when you need it, especially if you have a complex financial situation, are self-employed or experience irregular earnings. But remember to weigh the pros and cons carefully and explore alternative loan options.
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