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People shopping for a home and a mortgage may have heard the term “Portfolio Lender,” and wondered at its meaning.
In many cases, a borrower who does not qualify for a conventional loan program from Fannie Mae, Freddie Mac or FHA is told to seek out a portfolio loan from a portfolio lender.
Simply defined, a portfolio lender is a bank or other lending institution that makes mortgage loans with the intention of holding the loans in their investment portfolios. Portfolio lenders can often offer consumers greater flexibility in the loan granting process, as well as down the road, than lenders who make mortgage loans with the intention of selling them – either immediately or at some time during the term.
However, portfolio lenders are not garbage cans. They do not accept every loan request and in today’s market many portfolio loan programs are actually much more difficult to get approved for than
Today, portfolio lenders are more likely to be smaller community banks-often privately held-that have more discretion in the way they do business than larger, stockholder-driven institutions. These banks can make lending decisions based on the intangibles as well as the tangibles of a transaction. For example, a long term banking relationship with a customer might influence a positive loan decision, even in a situation where there had been a period of poor credit. Such a situation would more likely draw a ënoí from a non-portfolio lender, even if it were explainable.
To more fully understand the portfolio lending concept and its implications for consumers, it is first useful to understand the alternative to portfolio lending-the selling of mortgage loans.
One might ask: How can a bank sell a mortgage? Why would a bank make a mortgage loan, only to sell it? Who would buy mortgages, and why?
Mortgages are considered business investments. For true portfolio lenders, mortgages are also investments in customers and in the communities served, allowing for growth and helping to maintain a healthy social and business environment.
In mortgages, as in other investments, there are anticipated returns on investment (the interest paid over the life of the loan) and degrees of risk (the possibility that the interest and/or the principal will not be repaid.)
Like other investments, mortgages-with their potential risks and rewards-can be sold by one investor to another. To offer an investor sufficient return on investment on a mortgage that was made at market interest rates, the mortgage originator may have to sell at the loan at a discount. Or, to offer a secondary market investor a hedge against extra risk, the originator may have to make riskier loans at rates well above market rates.
Banks and other mortgage lending institutions are actually investors. They allocate a percentage of their total assets to mortgage loans based on what is prudent to maintain a balanced portfolio. If, at a given time, they feel they have too great a percentage of assets invested in mortgage loans, they may decide to sell some of the loans to other investors. This is a way to hedge risk and to increase liquidity.
Many institutions use the funds received from selling mortgage loans to make further mortgage loans. This can be beneficial to a community that needs a larger pool of mortgage funds at a particular time than it can generate from bank deposits or other sources.
On the other hand, a lender may want to add to its overall percentage of assets put into mortgages and then hold them in its investment portfolio in order to realize the full value of the investment. Some portfolio lenders holds mortgages because it is important to build a solid, long-term relationship with borrowers through the process of servicing the mortgage over the years.
To understand the value to consumers of working with a portfolio lender, it is helpful to take a look at the investors who buy the mortgages originated by others. These investors make up what is known as the secondary mortgage market. For residential mortgages, the largest investors in mortgages are two quasi-governmental institutions: the Federal National Mortgage Association (popularly known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (popularly known as Freddie Mac,). There are several other private groups, such as Residential Funding.
These organizations buy large numbers of loans from banks and other mortgage originators and then re-package the loans in groups of similar type loans to be sold again as what are known as mortgage backed securities. These securities are traded like stocks and bonds.
Because they buy so many mortgage loans from original lenders, and because they desire to limit risk for buyers of their mortgage-backed securities, Fannie Mae and Freddie Mac have developed market standard guidelines for the loans they will be willing to buy. The guidelines include such particulars as the percentage of total income that is allowable for a borrower to spend on mortgage payments and total debt service, maximum loan amounts, down payment sources, and other particulars. Lenders that wish to sell mortgages to Fannie Mae and Freddie Mac must make loans that conform to these strictly enforced underwriting guidelines.
These guidelines may prevent homebuyers from being approved for their mortgages. This is where a portfolio lender can help. Portfolio lenders cannot be reckless in granting loans or they would not be in business very long. But they can and will go somewhat beyond the guidelines for good reason. One example is making loans to low-income buyers to help them achieve home ownership. This action is a decision that is good for the community as well as for the homebuyer. Another example is lending to someone whose credit rating suffered while out of work for an extended period, but who is back on track.
What if a consumer has no problem conforming to Fannie Mae or Freddie Mac guidelines to buy the home he or she wants? Should they be interested in whether they are dealing with a portfolio lender or not? Absolutely. They should know – and have the right to know in advance – if the lender intends to sell the mortgage.
Within three days of taking an application for a mortgage, the lender is required by federal law to give the applicant a servicing disclosure that reveals its track record of selling mortgages it originates, including a three-year history. The lender should also disclose its intention for the mortgage in application: to be sold, or to be held in portfolio. In any event, homebuyers should ask the bank its intentions. Why? Because their involvement with the lender does not end when they close on the new home.
Mortgage lending has two parts: loan origination and loan servicing. Origination involves all of the steps from application through making the loan. Servicing involves accepting and allocating mortgage payments and handling any correspondence or problems that may arise over the life of the loan.
When a lender sells a mortgage, it can sell the mortgage and the servicing, in which case the consumer would be notified to make mortgage payments to the new owner of the mortgage. However, if a lender sells the mortgage, but retains the servicing, the consumer may never know the loan has been sold – until a problem arises.
Take the example of a borrower who is downsized out of a job. He or she might call the banker who handled their mortgage loan and has been receiving their ontime payments ever since to request some short term relief, like paying interest only for awhile. Imagine how unpleasant when the borrower learns the mortgage has been sold and such a decision will be made not by the friendly banker who knows them but by some unknown investor. It is unlikely that the borrower would get the temporary relief requested and could end up in foreclosure.
By understanding portfolio lending, home buyers have an important tool to help assure that not only will the purchase process go smoothly, but also that they have set the stage for happy homeownership over the life of their mortgage.
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