Lending Outside the Box

Written by Posted On Monday, 22 February 2021 00:00

Most mortgage lenders offer the same suite of loan programs. In fact, most loans approved today are either conventional loans underwritten to standards set by Fannie Mae or Freddie Mac or are government-backed programs to the tune of VA, FHA and USDA programs. Individual lenders can also apply their own internal requirements on top of the ones for conventional or government loan programs. These additional requirements are referred to as “overlays” in the mortgage industry. Overlays will reduce the risk of issuing a mortgage loan.  

For example, if a minimum credit score for an FHA loan is 580, a lender can up that requirement to 620. It’s perfectly legitimate and as an aside it’s also why one lender can approve a loan application on the same loan program that was turned down by another.

Underwriting to existing guidelines also makes loans eligible for resale in the secondary market. Secondary markets are established in order to provide liquidity in the mortgage industry. Selling a loan replenishes a mortgage company’s credit lines, enabling it to continue making more home loans. But the ability to sell also means approving a loan using the appropriate standards. Sometimes though, a loan can’t be approved using existing guidelines. Sometimes lenders can offer a program that doesn’t quite fit current markets and issue a loan approval ‘outside the box.’

Such loans are often referred to as ‘portfolio’ loans. A portfolio loan is one where the lender has no intention of selling the loan but instead keeps it in its portfolio. Lenders who offer portfolio loans often do so to address a particular market niche. If the market is large enough, lenders can produce a brand new loan program to address that market. This often results with loan programs offered and marketed to the real estate and consumer industries. And just as there are investors in the secondary markets, there can also be buyers for a portfolio loan. 

For example, newly licensed physicians often graduate with more than their fair share of student loans. Once graduated, these loans will become due. At the same time, new doctors won’t be making the sort of money right away compared to what they would be making with a few years of practicing under their belt. 

These new physicians will then have very high debt-to-income ratios, much too high to be approved using conventional standards. Instead, a lender could issue the mortgage loan knowing that while debt ratios are high now, they won’t be later and they’ll have added a new happy borrowing customer to their database.

‘Outside the box’ mortgages can be produced for most any variety of reasons. And as long as the mortgage lender has successfully identified a consistent market for a brand new loan program, there’s no reason why the lender would stop making these loans.

For consumers, it might be a little difficult to locate a lender who does offer such loan programs but they’re there. Even if an individual lender doesn’t offer a particular portfolio product, they can know who does. In this instance, they can go ahead and approve the loan using these different guidelines and then ultimately sell the mortgage to another lender who will keep the loan internally.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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