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Key takeaways
- Portfolio loans are a type of mortgage that lenders originate and retain instead of selling on the secondary mortgage market.
- Portfolio loans offer more flexible underwriting standards and faster funding times than conventional loans, but often come with higher interest rates, closing costs and down payments.
- Borrowers who don’t qualify for traditional loans may be eligible for portfolio loans.
- Portfolio loans are typically offered by community banks, and borrowers may need to work with a mortgage broker to find one.
With most mortgages, the lender who originates the loan doesn’t actually hold onto it. Instead, it sells the mortgage on the secondary mortgage market, which helps free up capital so it can loan money to more borrowers. There are, however, some exceptions to the rule: loans that don’t wind up being bought and sold. These are called portfolio loans.
What is a portfolio loan?
A portfolio loan is a kind of mortgage that a lender originates and retains instead of offloading or selling on the secondary mortgage market. A portfolio loan stays in the lender’s portfolio, or “on the books,” for its full term, never entering that web of behind-the-scenes buying and selling.
Why does that matter? With a portfolio loan, the lender gets to set the standards— what kind of credit score they’ll approve and how much money they’ll offer to the borrower, for example — instead of adhering to the standards put in place by the Federal Housing Finance Agency (FHFA) and used by Freddie Mac and Fannie Mae, the government-sponsored enterprises(GSEs) that back and buy most mortgage loans in the U.S.
How portfolio loans work
Procedure-wise, a portfolio loan has plenty in common with non-portfolio mortgages: You’re still going to apply to borrow a chunk of money, and a lender will assign a level of risk to you as a customer based on the likelihood that you’ll pay it back. That risk level helps determine the loan interest rate and other terms. If you agree to these terms and take out the mortgage, you’ll receive a lump sum that you agree to repay in monthly installments over a set time.
While the application process is largely the same, portfolio loans can offer faster access to financing, more flexible repayment terms and potentially higher loan amounts than other types of mortgages.
How do portfolio loans differ from traditional mortgages?
It depends somewhat on how you define “traditional mortgage.” Like most mortgages that originate in the U.S., portfolio loans are conventional loans — that is, issued and funded by a private lender.
However, the majority of conventional loans — around 70 percent — are also conforming loans: They conform, or adhere, to the criteria set by the FHFA, which makes them eligible to be purchased by Fannie Mae and Freddie Mac. Since portfolio loans don’t aim to be bought by the GSEs, they are often non-conforming, meaning they don’t necessarily meet the FHFA criteria (which, among other things, dictate a maximum loan size).
Portfolio loans are also a type of non-qualifying loan (non-QM loan for short). Such loans differ from the norm in that they don’t adhere to the home-loan standards set by the Consumer Financial Protection Bureau (CFPB). These standards mandate certain features mortgages may or may not have, and certain underwriting practices lenders must follow, to ensure borrowers can repay the debt.
Otherwise, though portfolio loans aren’t bound by the same requirements as loans that are backed by Freddie Mac and Fannie Mae, or fit the CFPB’s Qualified Mortgage rule, they’re not all that different from mortgages in general.What does vary is the eligibility criteria for a portfolio loan. In general, portfolio loans offer more lenient underwriting standards for borrowers. As a result, portfolio loans may be more accessible for aspiring homeowners who are struggling to get approved for a mortgage. However, with more lenient standards can come higher interest rates, larger down payment requirements, bigger closing costs and additional fees.
All this reflects the risk the portfolio mortgage lender is taking by keeping the loan on their books, and not selling — or being able to sell it — on the secondary mortgage market. For the lender, a portfolio loan comes with one key difference: 100 percent liability if the borrower defaults.
What are the expected interest rates, fees, and payment terms for portfolio loans?
Borrowing money is never free: There are always going to be fees and closing costs associated with a mortgage. In the case of portfolio loans, those fees and costs are often a little higher than with traditional loans to compensate the lender for their additional risk. For example, an origination fee might be as high as 4 to 5 percent (in contrast, qualifying loan fees are capped at 3 percent). Points are negotiable, especially if you are the type of depositor they want as a customer.
A portfolio loan usually comes with the same features as a traditional mortgage: a fixed interest rate over a 30-year term that reflects the financial profile and assessed creditworthiness of the borrower. But the interest rate is almost always greater than that of comparable government-backed or conventional loans, varying from 0.50 to 5 percent above market rates.
Another cost to keep in mind is the down payment. A portfolio loan will typically require more upfront money than other types of mortgages — often at least 20 percent. In comparison, FHA loans allow down payments as low as 3.5 or 10 percent.
Other features that might differ: prepayment penalties, grace periods for missing payments and the right to assign to loan (that is, for the borrower to let someone else assume the mortgage).
Who is a portfolio loan best for?
Portfolio loans allow borrowers who don’t meet Fannie and Freddie’s conforming loan requirements the ability to still qualify for a loan. This borrower might be someone who doesn’t have earned income but does have significant assets; a real estate investor; a small business owner or a self-employed worker. Borrowers with high debt-to-income ratios (DTIs) or credit scores below 580 may still be eligible for portfolio loans, and those who have declared bankruptcy might qualify in a shorter time.
For example, North American Savings Bank‘s website features a portfolio loan that requires a 20 percent down payment (vs. 3 to 10 percent for conventional loans), a debt-to-income ratio of 48 percent (vs. the standard 43 percent for conforming/qualified loans), and two years of seasoning after bankruptcy (vs. four years for conventional loans).
Pros and cons of portfolio loans
Pros
- Bigger loan options: Borrowers who need an outsized mortgage or other special terms might find more flexibility with a portfolio option.
- Flexible underwriting requirements: Borrowers who don’t have a stable earned income, holes in their credit histories or scores that don’t fit other standard criteria might qualify for a portfolio loan.
- More hands-on or personalized service: Many portfolio lenders are community banks with a connection to the area. That can mean better customer service or more willingness to find creative solutions.
Cons
- Potential for a much higher interest rate: Remember that with a portfolio loan, the lender is losing the chance to resell the debt in the secondary market. That’s an opportunity cost, and the lender might charge you a higher interest rate to make up for it.
- Bigger fees: The lender might also charge more or more onerous fees in exchange for its flexible underwriting and additional risk.
- Still some standards to meet: Sometimes, lenders still want the option to sell the portfolio loan down the line. In that case, you might have to meet many of the usual underwriting requirements imposed by Fannie and Freddie.
How to get a portfolio loan
Portfolio loans aren’t advertised outright; you won’t find a lender simply by comparing mortgage rates. You might need to work with a mortgage broker who can match your specific needs with a lender who specializes in, or at least offers, portfolio loans.
Always check first with the bank you already have accounts at, personal or business (if they can’t oblige you, they might have a recommendation). You could also try a local community bank. Bear in mind, though, that it may reserve this type of financing for existing customers with substantial assets. Still, it’s worth considering.
You can also search online. But be careful: Predatory lenders often advertise portfolio and other sorts of non-traditional loans. Make sure any institution you deal with is an FDIC member and listed with the NMLS (Nationwide Multistate Licensing System / Nationwide Mortgage Licensing System and Registry). You can also ask for blank copies of the mortgage documents they will use for your loan, and have a real estate attorney review it for any unusual features, charges or conditions.
Bottom line on portfolio loans
Portfolio loans have a variety of pros and cons.
On the plus side, lenders may be more flexible if you have special circ*mstances relating to how you earn your money or your credit score or if the size of the loan or the nature of the underlying real estate keeps you from qualifying for a traditional conforming loan. On the down side, since lenders will be risking their own money, they might require a higher down payment, bigger fees, or — depending on the size of the loan — two home appraisals.
This is not to say a portfolio loan is a less-desirable choice. But before concluding it’s your best option, be sure to exercise extra due diligence in examining it and making sure that you fully understand all the terms.
