The Return of Portfolio Lending

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For a long time, Fannie Mae and Freddie Mac had a policy that they would not fund investment property (non-owner occupied) beyond 10 loans for a given investor. Although it did impact a certain number of investors, for most folks that rule just never came into play. They have now reduced that limit to 4 loans, which is putting an awful lot more investors in the position of needing a portfolio loan.

Portfolio loans are loans where the lenders originate the loan with the intention of holding it themselves. In recent years, this has been a very limited niche, and even those A paper loans written with the full intention on the part of the lender to hold it themselves were often underwritten to Fannie and Freddie standards, so that they could sell such a loan. Not that there were very many of those.

Portfolio loans largely went away because the tradeoff between rate and costs is much higher than the standard securitizable loans. In plain English, the rates are higher. When the lender originates a loan and sells it on Wall Street, it gets an immediate return of 2.5 to 4 percent on its money. Not as much as holding a six percent loan for the year, but they can turn right around and use the money to sell another loan. Lenders don't have any trouble getting four to six loan sales on the same money per year, some manage eight or better, and twelve is possible, if unlikely. Therefore, they make anywhere from 10% to maybe 25% per year by selling the loan repeatedly, as opposed to about six percent for holding it. Which of those do you think the average lender sees as more attractive, particularly if they also retain servicing rights and make money that way without risking any of their own?

So if the lender is not going to be able to sell the loan, but rather have its money tied up until you decide to sell or refinance the property, then they're going to want something more akin to the 10% or better return they get on their money by originating and selling the loans. Portfolio loans have a higher rate for the same cost; albeit a much smaller difference than when I first wrote this article. Some people will tell me they don't want their loan sold. I ask why, and they tell me about the hassles and ending up with an unknown company. I explain that the contract is the contract, and the only differences if your loan is sold are the name on the check and the address on the envelope (or, if you pay online, the routing number you use). For those that still come back with "I don't want my loan sold," I then say, "Well, then it sounds like what you want is a portfolio loan. The interest rate will be higher, meaning your payments will be X dollars per month higher, and your cost of interest will be higher." Them's the facts. Some lenders will lie about it to get clients to sign up for their loan, but that doesn't change the facts. They can deliver a portfolio loan, or they can deliver a regular loan where the lender is still going to sell that loan. Which would you rather have, an honest discussion of alternatives or someone who chose one alternative without consulting you? Because the loan they deliver will be one or the other, and whether it's the choice you would have made is mostly a matter of luck.

To be completely honest, even portfolio loans can be sold. However, not being designed with standard loan packages in mind, it's harder. Selling portfolio loans is a harder thing than what Fannie and Freddie do, as the ways in which portfolio loans are underwritten is not written to some broad industry standard. Selling portfolio loans is more common now than it was a couple of years ago, but the same lender generally retains servicing. Not every lender offers portfolio loans, as they are a different thing entirely to the corporate finance people than the standardized loans Fannie and Freddie require.

But for those that do, they allow that lender to make the underwriting decision by whether they are comfortable making such a loan, rather than whether or not it meets standardized criteria for Wall Street. This can enable those lenders who do offer portfolio lending to be able to make a certain specific loan, where a lender with its eyes fixed solely on Wall Street does not have the option of saying "Yes."

There are a fair number of loan niches that have always been portfolio loans. Many commercial loans, and loans for investors with over ten properties, to name two. Traditional "non-conforming" loans are not one of them, however. Just because Fannie and Freddie couldn't buy them doesn't mean nobody would. In fact, because they were underwritten to Fannie and Freddie standards in all matters except loan amount meant they were sought after, especially as opposed to subprime loans. But just because portfolio loans are not underwritten for Wall Street doesn't mean that the lenders can ignore Federal Reserve regulations, for instance the one about "Must be able to repay the loan from a source other than additional borrowing against the property". For that, you have to go hard money.

Final point: Because the interest rate for portfolio loans is higher, and therefore the cost of borrowing the money, there are going to be a lot of properties that would be a good investment for someone able to qualify under Fannie and Freddie's rules, where they would not be a good investment for someone who needs a portfolio loan. This is likely to constrain prices from rising to a small degree, and force rents to rise to a somewhat higher degree. If your landlord can't make it work on the basis of the rent you're paying, they have two real choices: Raise your rent or sell the property. Nor is the second alternative any kind of relief. If that landlord couldn't make it work, why would you think the next one can? That's assuming the purchaser doesn't plan to live in it themselves from day one. I have an inflexible rule with tenants where my clients don't want to keep them: They must be out before close of escrow. I suspect most buyer's agents are the same way. One of the fall-outs from the bursting of the real estate bubble that most people don't realize yet is that the economic factors which kept rent increases low for the last decade or more are all gone now. Furthermore, if someone is looking to buy an investment property, the cash flow is going to have to work from day one. If it won't, they're not going to buy it, and it will never become a rental property in the first place. On a $300,000 loan, a portfolio loan instead of a securitizable one means a difference of over $500 per month in the cash flow requirement, which translates to rent increases, and not just from the big landlords with portfolio loans.

Portfolio lending is set for a comeback. With Wall Street becoming ever pickier about the loans it wants to fund, and mortgage insurers restricting what they will insure, a strong lender with good reserves can make a lot of money in this environment by lending to selected borrowers with good credit and plenty of income, that "originate and sell" lenders cannot touch, because Wall Street isn't interested under current standards.

Caveat Emptor

Original article here


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This page contains a single entry by Dan Melson published on March 22, 2021 7:00 AM.

Earnest Money: Copy of a Check or Proof Of Funds? was the previous entry in this blog.

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