Is a Portfolio Mortgage Right for You?

A portfolio loan is one that the lender keeps on its own balance sheet rather than sells on the secondary mortgage market. (Getty Images)

A portfolio mortgage sounds like a boutique product for elite investors, but it’s just a home loan that the lender keeps in its investment portfolio. This type of loan can be a viable choice, especially if you don’t fit the conforming loan mold.

Before you decide, learn what a portfolio loan is, how it differs from conforming loans and whether it might be the right choice for you.

What Is a Portfolio Loan?

A portfolio loan is one that the lender keeps on its own balance sheet rather than sells on the secondary mortgage market, where lenders buy and sell loans and servicing rights. Selling loans is one way lenders replenish their supply of funds to lend.

A lender can keep a loan in its own portfolio for various reasons. One may be that the loan does not meet minimum standards required by Fannie Mae and Freddie Mac, two of the largest buyers of mortgages. Although “doesn’t meet standards” has an ominous ring, this doesn’t mean it’s a bad loan. In fact, “historical analysis shows that banks tend to be more cautious about underwriting portfolio mortgages,” says Andrew Pizor, staff attorney for the National Consumer Law Center. Since the lender assumes all the risk of a portfolio loan, it may impose standards that are equally or more stringent than those imposed on other borrowers.

Another reason a bank may choose to keep a loan is to have more control over the price. Erik Schmitt, managing director for JPMorgan Chase, says that Chase can offer better pricing by keeping a loan in its portfolio, even if the loan is government-sponsored enterprise-compliant and meets all the requirements for resale on the secondary market. He notes that Chase holds nearly $200 billion worth of first-lien mortgages in its portfolio.

A portfolio loan is neither inherently bad nor good, but in some cases, there may be disadvantages compared with other kinds of mortgages.

Pros and Cons of Portfolio Loans

Pro: Underwriting flexibility

Since the lender assumes all the risk of a portfolio loan, it can impose any requirements and terms it chooses. The lender “can underwrite any way they want,” says Pizor.

That can work to your advantage, since the lender can be more flexible in its documentation requirements, for instance, or allow a lower credit score or higher debt-to-income ratio. This flexibility can help you be a homeowner even if you cannot get a qualified mortgage.

Con: Loss of some consumer protections

Pizor cautions that some consumer protections that apply to mortgages made since the housing crisis allow exceptions for portfolio loans. Portfolio mortgages are not subject to the ability-to-repay rule, for example.

One of Fannie Mae and Freddie Mac’s requirements is that the lender must show that the borrower has proven his or her ability to repay the loan, typically by providing certain types of documentation like recent pay stubs and the last two years of tax returns. If you cannot provide the required documentation, a portfolio loan may be your only option.

Pro: Personalized customer experience

Schmitt says that Chase holds many loans on its books to borrowers who candemonstrate an ability to repay. Many of Chase’s portfolio loans are “prime ATR [ability-to-repay] underwritten” to high credit-quality customers. “QM [qualified mortgage] loan requirements are overly prescriptive and don’t allow the top customer experience that we want to offer,” he says.

Con: Potentially costly

A portfolio loan could include unpopular and potentially costly terms like a prepayment penalty. Also, in many cases, portfolio loans come with higher interest rates than loans that are destined for the secondary mortgage market.

One reason for the higher cost is that the lender has less flexibility in how it can manage the asset – in other words, it can’t sell the loan – and is assuming all risk associated with the loan for the duration of the loan term. Another reason for the higher cost is that a borrower who cannot provide traditional documentation may be viewed as a bigger risk.

Portfolio Loan Rates

The interest rate on a portfolio loan tends to be at least 1 to 2 percentage points higher than the best rate for a conforming loan. Some portfolio loan rates are even higher, depending on the lender and the borrower.

For a wealthy individual who is being courted with a personalized loan, rates may not be an issue. Depending on many variables, says Schmitt, pricing could be better or worse than average market prices elsewhere.

Chris McBrearty, certified mortgage planning specialist and loan officer at Fairway Independent Mortgage Corp., says, “Some banks have private banking products for their customers with large assets. They want to keep the customer.”

Who Should Get a Portfolio Loan?

Generally, portfolio loans are offered to borrowers who need an amount that exceeds conforming loan limits ($453,100 for a one-unit property in most U.S. counties; $679,650 in high-cost areas; $721,050 in Hawaii), and borrowers who are unable to qualify for a conforming loan for some other reason.

“A portfolio loan is an alternative, nontraditional source of funding for people who miss the requirements for a conforming loan,” says McBrearty.

Portfolio loans can be the best type of home loan for many people who don’t fit into the typical homebuyer mold. Here are a few examples.

Self-employed: Many self-employed people go to great lengths to claim every allowable deduction and minimize their taxable income. While this is a great tax strategy, it can leave these folks looking poorer on paper. A portfolio lender may agree to examine bank statements instead of tax returns to analyze the borrower’s income and cash flow. This is a common scenario. The decision to apply for a portfolio loan is “almost always based on income verification – or the lack of it,” says McBrearty.

No credit score, good assets and income: A foreign national whose primary residence is not in the U.S. may have the means to buy a home but no way to satisfy residency and documentation requirements imposed by many conforming mortgage programs. This borrower may be able to make a healthy down payment and show stable employment, but not all lenders make mortgage loans to nonresidents. Note that some government-backed loan programs do allow international credit reports and foreign proof of income.

Likewise, “an American who has been living abroad may not have an American credit history,” says Pizor. “This borrower may not fit into the framework that major loan programs require.”

High down payment or high DTI: A borrower whose debt-to-income ratio exceeds the limit allowed by conforming loans but who can make a large down payment and otherwise is a very good applicant may find that a portfolio loan is the best or only option. Again, a portfolio loan can be underwritten to whatever standards the lender allows, and if the borrower has ample assets, the lender may be willing to overlook weaknesses in other areas of the application.

Choosing Between Portfolio and Conforming Loans

You’ll probably never have to choose between a portfolio loan and a conforming loan. If you meet the requirements of a conforming loan, the lender may never offer a portfolio mortgage as an option.

“Most borrowers don’t go the portfolio route, because the payments and rates are usually higher,” says McBrearty. “Portfolio loans aren’t necessarily bad, but you might not need it. Always get a second opinion if someone tells you you need a portfolio loan.”

A good loan officer will exhaust all conforming options before steering a borrower to a portfolio loan.

Pizor adds that common sense and due diligence are critical ingredients in the homebuying process. “Don’t assume that just because you are approved it’s the right loan for you. Make an independent analysis and be sure you really feel comfortable making the payments, and always leave room in your budget for unexpected expenses.”

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