Mortgage loans can fall into multiple categories, even more than one at a time. For example, a loan can be a fixed rate loan or an adjustable rate loan. At the same time, a loan can be used to finance a primary residence, a vacation home or one that is used for a rental property. Loans also have a category of conventional and government-backed. A conventional loan is one where the lender assumes the risk when approving a loan application. A government-backed loan is either a VA, FHA or USDA mortgage and is so-called because there is an inherent loan guarantee to the lender. Should a government-backed mortgage ever go into foreclosure the lender is compensated for part or all of the loss.
When lenders follow guidelines set for government-backed or conventional loans they then have the ability to sell those loans in the secondary market. Selling loans is important because it frees up more cash to make still more loans. Today, the most common conventional loans are those underwritten to standards established by Fannie Mae and Freddie Mac which constitute up to two-thirds of all loans issued today. Government-backed loan make up around 20 percent. But what about the remaining 15-20 percent of loans issued? Much of this remaining percentage is allotted for Portfolio loans. What is a portfolio loan?
A portfolio earns its moniker because the lender has no intentions of selling the loan to either Fannie or Freddie but instead keeps it in a “portfolio” and collects the interest on the loan each and every month. Portfolio lenders issue these programs for other mortgage companies to use when an application falls outside the box of a traditional mortgage.
For example, let’s say someone wants to buy a rental property but they want to leverage the transaction as much as possible and put as little down as possible. Fannie Mae and Freddie Mac will want their exposure at no more than 80 percent of the value of the property and government-backed loans can only be used to finance a primary residence and can’t be used to buy a rental. In this example, a portfolio loan can be the answer.
Perhaps this rental property is selling for $500,000. The potential buyers do some homework and determine that not only will the asset continue to appreciate over time but the monthly cash flow is rather healthy. They can buy the property and watch the value of the investment grow over time but at the same time make money each month. Yet a 20 percent down payment for a conventional loan would be $100,000 in this instance, much more than the applicants want to put down. Instead, they take out a portfolio loan that asks for only 5.0 percent down. They make the purchase and a few years later as the property continues to increase in value, they can then refinance the portfolio loan into a conventional mortgage.
Another instance where a portfolio loan can be used is when a buyer wants to buy several properties but only take out one mortgage. This transaction is referred to as a blanket mortgage and is a form of a portfolio loan.
Or maybe there is a condominium project that is considered by Fannie Mae to be “non-warrantable.” A condominium project can be labeled as non-warrantable for a number of reasons. Non-warrantable condos do not qualify for conventional financing using Fannie or Freddie programs. A common reason a project can earn the non-warrantable status is the number of rental units compared to units occupied by the owners. If for example, 51 percent or more of the units are rented out, a portfolio loan will be used because the project is non-warrantable.
A portfolio loan can be the answer when a self-employed borrower has some rather complex tax returns. Instead of providing various tax returns over the past two years for both personal and business filings, a loan program that uses the deposits listed on bank statements for the past 12 months can substitute for income tax returns.
Portfolio loans aren’t the most common by any stretch and they will have slightly higher interest rates compared to conventional and government-backed loans. But they do fill an important niche when traditional financing cannot be used.