Recently, one of our biggest clients had a large package of houses where he was going to refinance out of a hard money loan and into long term, permanent financing. One option he was considering was doing a portfolio loan with a small bank. For those of you who are unfamiliar with this type of loan, let me explain it.
A portfolio loan is a loan that is serviced by the underwriting lender (to be held on the lender’s books in their portfolio) and is not sold on the secondary market. These loans (also called blanket loans) allow a borrower to bundle or package more than one asset into a single loan with one monthly payment. Over the years, I have used portfolio loans with different banks where I have packaged multiple properties into a single loan.
In theory, they are easier. Hey, it’s one loan with one payment. If you have 30 houses, it’s much easier to make one payment vs. 30 payments. And let’s face it, we all pay enough bills every month, so who wants to pay 30 more! One payment each month sure sounds good. But before you consider a portfolio loan where you package several of your properties together, read the rest of this to understand not only the advantages, but also the disadvantages of using them.
If you are buying houses and keeping them as rentals eventually you are going to be exposed to portfolio loans. Why? As you may know (and as of the date of this writing) Fannie Mae allows 10 non-owner occupied mortgages before you have to seek other financing options. I reference the date here as Fannie Mae changes their rules frequently and so do the lenders who underwrite Fannie Mae loans with their overlays (additional rules on top of the Fannie rules).
To qualify for a Fannie Mae loan you must have good credit, a low debt-to-income ratio and some cash reserves. I have encouraged many clients over the years to do as many of these loans as possible as they have the best rates and terms, which ultimately leads to much higher cash flow. If you do not qualify for a Fannie Mae loan or you have exhausted your loan limit, small banks can be a great resource.
Small Bank Financing
When I refer to small banks, I mean any bank that is not considered a money center bank. Without going into the financial requirements that technically make up a small bank, they would not include Bank of America, Chase, Wells Fargo, Citibank, etc. which are large money center banks that do not offer these types of products. I have done a number of portfolio loans with small banks and so have several of my clients. The thing to keep in mind is small banks (that like to do real estate loans) like for you to package multiple properties into one loan. They get more collateral which helps lower their risk, and they are easier to manage internally for the bank. Here are the advantages and disadvantages based on my experience:
- You can finance a large package of properties as long as it is under the loan limit of the bank. Banks have limits based on their size as to how much they can loan. With the banks I have used over the years I have seen it range from $1M to a $60M loan limit per borrower. Individual loan limits are based on your creditworthiness along with the bank’s appetite at a given time for that particular loan.
- In the most recent market, I have seen banks offer up to 75% loan-to-value (LTV) and you can get cash out if you are refinancing up to the LTV, if you have owned the property for over a year. It’s going to vary by bank, so you will have to call around to find the terms that work best for you and your situation.
- Very competitive interest rates, which are based not only on market conditions, but also your creditworthiness and possibly the deposit relationship you have with the bank. Some banks have no deposit requirement and just want to do loans whether you open an account there or not.
- There is one set of loan documents that you have to execute, vs. a separate set for each property, allowing for much lower closing costs.
- One payment each month vs. many.
- Tracking the P&I (principal and interest) for each individual property in a portfolio loan is a time consuming battle and almost too difficult to administer. Also, if you are like most investors, you (as well as your CPA) will want to know the profitability of each individual property by itself. Running a P&L (profit and loss) statement without the P&I factored for each one will be not only time consuming, but extremely difficult.
- Probably the biggest disadvantage is when you decide to sell a property (or properties) that are under one loan.
- The first thing that happens when you sell is your bank will need to determine what the payoff amount will be. If you have been paying on the loan for a while there could be significant principal reduction that is applied to the overall loan, but this will not necessarily be applied to the individual property (or properties) that you are selling you’re your bank sends the payoff. So what does that mean? That means that your lender may adjust the payoff to an amount that is much higher than what it would be if you did an individual loan with a single promissory note and lien (not good!)
- Your bank will not automatically modify your payment unless there is a provision in your loan to accommodate this. You need to read your docs carefully to make sure there is a provision in here to do this, prior to going to closing. If it’s not there (which it most likely will not be) your cash flow will certainly be lower. This is because your payment remains the same, while you are now collecting a lower amount of rent.
- If your bank does make the adjustment for you, they may make you re-qualify for the loan again before any modification. What? Yes, that’s correct. If you have been in the loan for over a year, and sell a property (or properties) in your portfolio loan, you will probably have to submit your financials in order for the loan modification to take place.
- Your bank is more than likely going to charge you a fee to modify your loan. There will be some document fee from their legal team and there may also be some administration fee to complete the transaction.
Personally, I like portfolio loans with small banks. Sometimes they can be easier to get than a Fannie Mae loan depending on the bank you are using and your experience with them. However, I think the disadvantages far outweigh the advantages of packaging properties together in one loan. As an alternative, I would recommend doing individual notes and deeds of trust (the mortgages) and set your payments for each on auto-draft with your bank. After discussing this option with one of my biggest clients, they decided to go the individual route and are very happy they did. The cost was a bit higher, because you have individual docs that need to be created for each property, but these costs can be recovered in a relatively short timeframe.
Wells Fargo does offer a portfolio product but it is different from most smaller banks and not for purposes of this article.