When a real estate investor is looking at a portfolio loan as a way to accumulate, manage, and profit from investment properties, there are pros and cons to consider. Let's begin by defining the terms portfolio mortgage and portfolio lender.
A portfolio mortgage is simply a mortgage that is not sold into the secondary market. A portfolio lender is that provider who chooses not to sell the loan. The loans instead are held and typically serviced in-house. This allows the lender to maximize its profit from each mortgage loan but also subjects the lender to more risk.
While a portfolio lender might make a good partner for the individual investor seeking flexible terms, including the ability to acquire multiple properties under a single loan, there are some portfolio loan pros and cons to consider.
The pros of portfolio loans
A portfolio loan does not have to be -- and often is not -- a traditional conforming loan. That means it does not necessarily have to follow the very specific, intentionally constrictive, underwriting guidelines a lender has to follow for a government-insured FHA loan or any note to be sold into the secondary market through Fannie Mae or Freddie Mac.
Note: In researching portfolio lending, it's useful to keep in mind that conforming loans are often termed qualified mortgages (QMs) because they fit regulations that govern such factors as down payments and the ability to repay. Conversely, non-qualifying mortgages, or non-QMs, are often used synonymously with the terms portfolio loan and portfolio mortgage.
Flexible mortgage terms
Mortgage lenders who provide portfolio loans tend to be smaller community banks and credit unions. They may be more flexible in regard to down payment, credit score, past delinquencies and bankruptcies, and debt-to-income ratio and ability-to-repay rules as well as payment terms for once the loan is made. That's especially the case for mortgage programs aimed at helping spur borrowing among lower-income citizens in search of a home loan and anyone -- including real estate investors -- seeking to borrow to buy in economically distressed areas.
Portfolio loans tend to be investor-friendly
Portfolio lenders don't have to restrict how many investment properties an individual can finance with a single note or two, nor do they concern themselves as much with the uniqueness or condition of the properties to be purchased. And, instead of the borrower's income and other personal metrics, the portfolio lender can focus more on cash flow and the individual's business history. In some cases, seekers of non-QM mortgages may not even have to provide personal tax returns, if the cash flow being considered by the portfolio lender is based on rent rather than personal income.
The drawbacks of portfolio loans
Higher interest rates
A portfolio loan can end up being more expensive than an equivalent conforming loan. That's because a portfolio lender needs to offset the additional risk of a non-conforming loan by charging higher interest rates. That difference from a conforming loan can be particularly acute when it comes to variable-rate mortgages. A lender may well be quicker to boost interest rates on a portfolio loan than on a traditional balloon mortgage. That can be for both competitive reasons (conforming loans are presumably easier to refinance) and regulatory concerns.
Portfolio loans also can incur higher fees than their conforming counterparts that end up in the secondary market. One example: prepayment fees. They're strictly regulated for conforming home loans to be sold by the originator and in some cases are waived. The smart investor should find out if that's the case for the prospective portfolio loan. If the prepayment fee is to stay in place, try to negotiate the lowest fee available. Same with closing costs. Plus, keep an eye out for the easiest path available to refinancing to respond to falling rates or other market changes.