What Is a Portfolio Lender?
A portfolio lender is a bank or other financial institution that originates mortgage loans and then keeps the debt in a portfolio of loans. The loans are not re-sold in the secondary market. Conventional loans are issued by a lender but then sold to another lender who services the loan.
A portfolio lender generates fees from originating mortgages and also profits from the net interest rate spread (difference) between interest-earning assets and the interest paid on deposits in their mortgage portfolio.
- A portfolio lender originates and maintains a mortgage loan portfolio rather than selling the loans in the secondary market.
- A portfolio lender assumes more risk than a traditional lender by holding on to the loans.
- A portfolio lender generates fees from originating mortgages and also profits from the net interest rate spread between interest-earning assets and the interest paid on deposits in their mortgage portfolio.
- Portfolio lenders offer more options to borrowers but, they are typically more expensive and charge higher interest rates.
How Portfolio Lenders Work
Traditional mortgage lenders avoid the risks of holding mortgages; they profit from origination fees and then sell the mortgages to other financial institutions. There are pros and cons to both methods. Companies that profit from originating mortgage loans experience less risk and a more consistent profit stream. Portfolio lenders, on the other hand, experience more upside on their portfolio, but also more risk.
Accordingly, this type of lender is not beholden to the demands and interests of outside investors or other third parties. Portfolio lenders set their own borrowing guidelines and terms, which may appeal to certain borrowers. For example, someone who needs a jumbo loan or is buying an investment property might find more flexibility in working with a portfolio lender.
Advantages of Portfolio Lender Loans
- Loan Approvals: Prospective homebuyers may find it easier to qualify for a mortgage loan from a portfolio lender than a traditional lender. This is because portfolio lenders do not have to meet underwriting guidelines specified by secondary market buyers such as Fannie Mae or other agencies. For example, a traditional lender may be restricted to originating loans that meet minimum income requirements set by the secondary buyer. Since a portfolio lender keeps loans on their balance sheet instead of selling them, they have more flexibility in setting their approval criteria.
- Greater Flexibility: Portfolio lenders are often small, privately owned community banks that have more flexibility than larger financial institutions. For instance, when a portfolio lender is originating a mortgage, they could change several terms of the loan to fit the customer’s financial circumstances. They might allow the customer to make two monthly repayments instead of one monthly payment or require a smaller down payment.
- Investor-friendly: Mortgages offered by portfolio lenders are typically more favorable to property investors. Usually, they do not restrict the number of properties an investor can purchase. They also don’t require a property to be in a particular condition to offer finance. This is advantageous for investors who want to buy an old home to renovate. A traditional lender, on the other hand, may not finance more than five investment properties or may only approve mortgages on homes that are structurally sound.
- Lower fees on refinances: The FHA has imposed a new fee (as of Dec. 1, 2020) on refinances, called the Adverse Market Fee. This amounts to a 0.5% surcharge that applies to refinances of $125,000 or more that are sold by Fannie Mae or Freddie Mac. Portfolio lenders are not subject to this new fee so they may be able to offer better refi rates.
Disadvantages of Portfolio Lender Loans
- Prepayment Fees: Portfolio lenders may charge borrowers a prepayment fee. Although federal law limits the amounts lenders can charge, this can be an unexpected expense that increases the overall cost of the loan. Before a customer originates a loan with a portfolio lender, they should negotiate prepayment fees that allow them to refinance easily.
- Higher Interest Rates: A portfolio lender may charge higher interest rates to offset the additional risk they take for servicing the loan. If the Federal Reserve is increasing interest rates, a portfolio lender may increase their variable rates more rapidly to maintain their profit margins.