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Portfolio mortgages: What they are and how they work

Hallowell, Maine
Joseph Sohm/Shutterstock
Hallowell, Maine
Joseph Sohm/Shutterstock
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With most mortgages, the lender that originates the loan doesn’t actually hold on to the loan. Instead, it gets bought and sold on the secondary mortgage market, which helps free up capital and allow other prospective homeowners to borrow money. There are, however, some exceptions that don’t wind up being bought and sold. They’re 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 on the secondary mortgage market. Appropriately named, a portfolio loan stays in the lender’s portfolio, never entering that web of behind-the-scenes buying and selling. Why does that matter? Because the lender gets to pick the standards for the loans – 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 Freddie Mac and Fannie Mae.

How portfolio loans work

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 are going to be able to pay it back. However, portfolio standards often differ from Fannie Mae, Freddie Mac and government-insured loan requirements. Those tend to have rigid requirements around credit score, down payment contributions and debt-to-income ratios.

For the lender, a portfolio loan comes with one key difference: 100-percent liability if the borrower defaults. Because they are riskier propositions, plenty of portfolio loans may charge higher interest rates and higher origination fees for the borrower.

Pros and cons of portfolio loans

A portfolio loan can be a smart move — it may offer more liberal underwriting standards, require a lower credit score and a smaller down payment and allow you to borrow more than you could with another type of mortgage. In some cases, though, you may not want one. Here’s a rundown of the pros and cons of portfolio loans:

Pros

  • A good option if you have bad credit. Let’s say that a period of bad luck pushed down your credit score — maybe you’ve had a few months of low income or unemployment, or both. Financial hits like that don’t look good on paper, so you may not be able to get a typical mortgage. If you have a history of solid credit and consistent income otherwise, a bank may agree to offer you portfolio financing for a home, and with more flexible underwriting. It’s also why portfolio loans can be strong candidates if you need to refinance but your credit isn’t great.
  • Helpful for self-employed borrowers. Being your own boss can be a good feeling – until you apply to borrow a big chunk of money for a home. Traditional mortgage lenders will like to see steady employment, so a fluctuating income from independent contracting work or a small business might hold up your application. Portfolio lenders tend to be more willing to work with self-employed individuals .
  • Good for real estate investors. Many portfolio lenders are community banks with a connection to an area – a helpful characteristic for real estate investors looking to buy distressed properties for a fix-and-flip profit. So, if you’re looking for financing to help your real estate investing strategy, portfolio loans can be especially attractive.
  • More flexibility. One of the big differences between conforming loans and non-conforming loans (the classification that portfolio loans tend to fall under) is that borrowers can do things they can’t do with conventional loans – borrow more money, put less down and potential avoid mortgage insurance even with smaller down payments.

Cons

  • The potential for a much higher interest rate. Remember that with a portfolio loan, the lender is losing the chance to resell the debt into the secondary market. That’s an opportunity cost, and the lender may well want a higher interest rate to make up for it. The lender may also charge a higher interest rate in exchange for more flexible underwriting and more risk.
  • Costly fees. A lender might charge higher fees on a portfolio loan. Since they’re offering greater flexibility to borrowers who might not be able to qualify elsewhere, they can use that power to their advantage. Simply put, borrowers have limited options to compare.
  • Not always flexible. A portfolio loan is designed to be held by the lender until the property is refinanced or sold, but sometimes, a lender will want the option to sell the loan in the future. In that case, it might create a portfolio loan within Fannie Mae or Freddie Mac standards, so a borrower will have to meet many of the usual underwriting requirements. In this case, there’s little advantage to a borrower with poor credit, or one who needs a jumbo loan.

How to get a portfolio loan

You likely won’t find portfolio lenders simply by comparing mortgage rates. Whether you’re looking to buy a new home or refinance your existing mortgage, you’ll need to do a bit more digging to find lenders that offer portfolio loans. One of the best routes is to work with a mortgage broker, who works to match your specific needs with lenders that can meet them. Additionally, you should look into local community banks in your area to see if they keep loans on their own books. Just remember to compare portfolio loans with traditional options, too, to make sure you get the best deal.

Written by
Peter G. Miller
Contributing Writer
Peter G. Miller is a contributing writer at Bankrate. Peter writes about mortgage rates and home buying.
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