What is a Portfolio Loan/ Portfolio Lender?
A portfolio lender is a lender who does not sell your loan to someone else. Many lenders only keep mortgages for a short amount of time before they sell them off to Fannie Mae or Freddie Mac. Portfolio lenders, on the other hand, don’t sell their loans. They keep them in-house so they can earn interest over time. It’s a riskier move on their part, which is why many banks and credit unions don’t offer any type of portfolio loan.
Much of the profits banks make off of traditional mortgages are made from loan origination fees. The rest come from selling mortgages at wholesale prices on the secondary market. If you’ve ever bought a home and received a letter informing you that all future payments are to be made to a new company, this is why. Your original lender sold your loan for a quick (and certain) profit.
Because portfolio loans don’t need to appease the secondary market, they come with a variety benefits and drawbacks. However, if used wisely, they can be a valuable investment tool.
If you’re curious about portfolio loans and how you can use them to actualize your investment goals, keep reading.
When is a portfolio lender needed?
There are many scenarios a portfolio lender would be preferable to a traditional lender when buying a home. Here are some of the most common reasons home buyers turn to portfolio lenders when they are ready to buy a house.
Reason #1: When You Are Buying an Unwarrantable/ Non-warrantable Condo
Unwarrantable condos cannot be purchased with a typical mortgage product because they do not meet certain criteria. The condo itself is normally fine and 100% livable, but surrounding issues affect traditional financing (common issues are a low owner-occupied ratio and HOA litigations). The secondary market considers the loan risky and, therefore, won’t purchase it after closing. Because they won’t purchase it, traditional lenders won’t finance it.
One of the most common routes to purchasing a non-warrantable condo is through a portfolio loan.
Reason #2: When Traditional Banks Don’t Like Your Financial Profile
Portfolio loans are often given to people who have bad credit but otherwise have a decent financial foundation.
“Sometimes bad things happen to good people,” says Ted Lyons, a branch manager with Michigan First Mortgage that offers portfolio loans. “A portfolio loan is often the last line of defense. It fills the gaps that exist in traditional lending programs where a person’s personal circumstances just won’t fit into any loan box.”
Short sales, foreclosures, bankruptcies— just about anything negative on your credit report— can severely limit your lending options. Depending on the financial offense, they can stay on your credit report for 7-10 years. FHA loans are the most forgiving of all mortgage products when it comes to these things, but even they enforce a waiting period. For foreclosures, you’ll need to wait around 3 years, and for Chapter 7 bankruptcies, around 2 years. Another thing to keep in mind is that FHA loans come with loan amount limitations.
Ted Lyons adds: “If a person has an interest in buying a house that exceeds the loan limits for FHA, the only game in town for them is Fannie Mae and Freddie Mac who, if you’ve got a foreclosure or something similar on your credit report, will say come see us in seven years. Things in the past can’t be changed, and portfolio loans are often the solution.”
Portfolio loans in these situations come with a price, though— shorter repayment periods, higher interest rates, fees, possible balloon payments, etc. Many people use portfolio loans as a temporary solution until they can refinance to a more vanilla mortgage option.
“I always tell people we never lead with our portfolio loan, but we have it in reserve if and when it’s needed.”
Reason #3: When You Have a Low Down Payment
This option depends entirely on the lender and your situation, but buyers have often been able to get a portfolio loan with only a 3% down payment. This is a good option to have if your home exceeds normal purchase prices where coming up with 3% is still a lot of money.
Reason #4: When the House You Want is a Fixer Upper
Underwriters for traditional lenders will often shoot down loans for houses that don’t meet basic criteria. The house needs to meet a minimum specifications to ensure it provides sufficient collateral for the amount of the loan. This especially holds true for FHA loans, which has its own checklist separate from that of the bank’s. To satisfy the secondary market, the home needs to have some value to it should the borrower default on his or her payments.
Portfolio lenders will consider all loan requests because, here again, they don’t have to go by the guidelines established by Fannie and Freddie. Obviously, if the house needs to be demolished, no lender is going to finance it, but if it just needs a few things to become a smart investment, a portfolio lender might be willing to have that conversation with you.
All portfolio loans go case by case. It has to make sense for everyone, but many investors have found financing solutions with portfolio loans for fixer uppers.
Reason #5: When You Are an Investor with Many Properties
The property mortgage limit for traditional lenders is ten. Go over that number and you have to pursue alternative financing. Portfolio lenders are the answer for a lot of investors looking to further grow their portfolio. They don’t have universal limits and standards. If you have ten mortgages with a traditional lender, it will definitely be more difficult to obtain a portfolio loan, but it won’t be impossible like it would going the traditional route.
Reason #6: When You Need a Last Minute Financial Fix
Portfolio loans have been known to help people out in the dire straits.
“I had a couple who were in the end throws of a foreclosure,” says Ted Lyons. “The title company was delivering checks to the attorney’s office before close of business that day, so the home wasn’t going to belong to them the next day.
“I had an ex-husband required by the court to refinance his wife off the mortgage. He had just filed bankruptcy and finished with that process three months prior.
“The rest of the lending world says, ‘sorry, that’s life.’ Meanwhile, I was able to help them out.”
If you’re thinking portfolio loans sound too good to be true, and that they are probably a legal form of usury, think again. Though portfolio loan rates are higher than a standard mortgage, they are still lower than many loan products on the market, and are often only higher than going rates by a few percentage points.
Reason #7: When You Don’t Want the Purchase to Show up on Your Credit Report
Believe it or not, portfolio loans often don’t show up on your credit report. You’ll want to discuss this with the lender prior to taking out the loan if this is your primary motivation for wanting one, but many lenders don’t report portfolio loans to the credit bureaus.
This could be a decent strategy for a variety of reasons. Say, for example, you know you’re going to need a personal loan for your business in the near future, but you want to jump on an investment opportunity that’s appeared on the market. To capitalize on the situation, you use a portfolio loan. With it, your credit score wouldn’t change, leaving it in a stronger position prior to you taking out the personal loan. The personal loan would thus have a better interest rate, meaning it wouldn’t cost you as much to pay off.
Reason #8: When You Are Purchasing Multiple Properties and Want Them Under the Same Mortgage.
Eric Ducommun, a real estate investor, professional pilot, and author of two investing books (which you can buy on Amazon), got into portfolio loans because he wanted to buy multiple properties but didn’t want to apply for different mortgages for each and every one.
“For my first investment I purchased another investor’s portfolio off of him— it was 11 homes, 14 units. Some people would actually prefer to divide that up over multiple mortgages, which is how the person I bought the portfolio from did it. But one of the appeals to me of having one blanket loan financing all of the properties was I didn’t have to apply for multiple loans. Getting a portfolio loan streamlined the entire process. I have one note. I have one payment each month. It is a lot more professional and clean.”
Are there different types of portfolio loans?
Portfolio loans are often simply what they need to be. However, you technically have the following options:
Balance Sheet Loan—for the purchase of a single property.
Blanket Mortgage—for the purchase of multiple properties at the same time.
Refinance—to replace your existing mortgage with a portfolio loan.
Jumbo Loan—to purchase a property with a large purchase price.
Balance Sheet Loan
Balance sheet loans are best used by people who won’t qualify for a loan from a traditional lender— meaning they, or the house they want, won’t get past the underwriter. It’s also a good option if the borrower doesn’t have a high down payment. Presently, some portfolio lenders are lending up to 97% of the purchase price, which is better than FHA loans.
Typically, the minimum loan amount is usually $100,000, and the loan term can be anywhere from 3-30 years (though anything above 20 is unusual). If you’re looking to purchase something less than $100,000, still call portfolio lenders near you, but you’ll likely need to consider personal loan options.
A blanket mortgage is a single mortgage that finances the purchase of multiple properties. It’s a great option for investors purchasing a few fixer-uppers at the same time. Traditional blanket mortgages will only allow for the financing of 4-10 properties, but portfolio lenders allow you to go beyond that number if needed.
It can take 2-3 months for a blanket mortgage to go through, so be sure to discuss this with your lender.
Portfolio loans are used to refinance for a variety of reasons. As mentioned above, it can be a valuable tool during a divorce if a person needs to get his or her spouse off the mortgage.
A cash-out refinance can also be used in emergencies or investment opportunities.
FHA loans only go so high, and if lenders don’t like your financial profile, you may not be able to get a traditional jumbo mortgage product. A portfolio jumbo loan can enable homebuyers to purchase real estate that they otherwise wouldn’t be able to.
How do you find a portfolio lender?
Smaller credit unions and banks are your best bet, but even that’s not a guarantee, you’ll want to call and discuss portfolio loans with the bank or credit union’s loan officer. You can try to dig around on the web, but portfolio loans aren’t usually advertised. They’re kind of like secret dishes offered by a restaurant. They’re not listed on any website, but if you know about them, you can take advantage of them.
But be careful.
Some banks and credit unions say they offer portfolio loans, but they don’t really. “They often have an investor waiting to buy the loan from them once they close it,” says Ted Lyons. This may not sound like a big deal because the conditions won’t be established by Fannie Mae and Freddie Mac, but there will be conditions there nonetheless, possibly making the loan not work for you.
Additionally, some portfolio lenders are only out to make a quick buck. “They’re not necessarily predatory, but they’re not in the business of helping people. They’re in the business of maximizing their own return right then and there once they close the file. It’s a lot of sky high interest rates, balloon payments, or ‘we don’t do fixed rates.’ Take it or leave it kind of stuff.”
So banks need to make money just like any business, but the point of taking out a portfolio loan (or any loan, for that matter) is to put yourself in a better financial position than you were beforehand. To do that, you have to find the right one. You can do this by yourself by having numerous discussions with loan officers and branch managers, but, if you can afford it, there’s an alternate route you might want to consider (discussed below).
So how do you find the right one?
Eric Ducommun recommends working with a CPA.
“I reached out to a CPA in my hometown for help with my taxes, but also because I needed connections with local bankers. One of the biggest values my CPA brings me is connecting me with financial professionals. When I reached out to banks on my own, I kept walking into brick walls. With the CPA, once we got all of my business assets and income in order into a nice and clean personal financial statement, my CPA was able to shop my loan request around with people he had established connections with. I immediately got picked up for a portfolio loan from a reputable bank.”
Eric has a lot of useful advice like this in his book Portfolio Loans: Scaling Your Real Estate Investments where he details exactly how he went about getting a portfolio loan and explains his reasoning for each and every step (including why it paid off for him to also work with a lawyer). It’s a good read, and is well worth your time.
What are the drawbacks of a portfolio lender?
May Have a Higher Interest Rate
Sometimes a portfolio lender may charge higher interest rates to borrowers. This is done to offset any risk that may be associated with the loan. Though portfolio lenders are independent lenders, they do still closely watch the Federal Reserve. Should the Fed raise or lower rates, portfolio lenders will follow suit to some degree.
If you’re using a portfolio lender because of issues on your credit report, expect to pay three percentage points higher than the going rate.
May Charge Higher Fees
Portfolio lenders are also known to charge prepayment penalties. They are only allowed to charge but so much, but regardless of how much they charge it still increases the total cost of the loan should you pay off the loan early (whether by paying by cash or refinancing). On the plus side, it’s easier to negotiate with a portfolio lender because you’re working with real live people. In the beginning, before you’ve taken out the loan, if you don’t like the prepayment fee, throw it back at them. They may work with you.
May Require a Balloon Payment
Balloon payments are a financial obstacle, but they aren’t the end of the world. Balloon payments may be required after 3, 5, or 7 years. To avoid them, you can often refinance your portfolio loan into a standard loan. In fact, this is the initial game plan for many borrowers who take out portfolio loans to begin with. When it’s time make a balloon payment, their credit situation has usually sense resolved. They are able to get a conventional mortgage without having to pay the remaining balance in full on the original portfolio loan.
Is there a typical set of loan terms that come with portfolio loans?
There isn’t anything typical with a portfolio loan. Each loan is unique. It depends on your financial profile, the condition of the house, and the purchase price.
“There isn’t an algorithm or a given score that borrowers must satisfy,” says Ted Lyons. “And normally, the loan application goes to the highest levels within the bank, and it’s a discussion— a bet— where the bank tries to understand the circumstances that exist with the loan and what makes the most sense.”
Here again, portfolio loans are ‘common sense’ loans. Banks are going to come up with terms that make sense for them, and hopefully you, too.
Lastly: You May Not Need a Portfolio Loan
You may have been denied a mortgage by countless lenders, but that may have more to do with bad luck than anything else. A portfolio loan may not be required.
Each bank has what is known as an overlay. A lender overlay is basically another set of rules that lenders tell their underwriters to follow when it comes to specific loans— which, unfortunately, are harder to satisfy. For example, a bank may service FHA loans, and yet require a minimum credit score of 680 even though FHA advertises that the minimum is 580. Though the bank will likely receive pressure to change its rules, they are allowed to set their own criteria for loans they disburse.
Perhaps you’ve been denied numerous times, but that may be because the banks weren’t hurting to issue that kind of loan at that point in time.