Purchasing a home is one of the biggest financial steps a young couple can make. With a conventional home mortgage, you need to make a downpayment of 20 percent. In contrast, FHA and portfolio loans offer you a low downpayment alternative. While some lenders specialize in offering one of these types of loans, most lenders issue both FHA and portfolio mortgages.
Congress founded the Federal Housing Administration in 1934 with the intention of making it easier for people to buy their own home. The FHA doesn't write loans, but it does guarantee loans. If your mortgage goes into foreclosure, the FHA covers some of the lender's losses. Normally, lenders sell FHA-backed loans to government-backed mortgage investment companies such as Freddie Mac and Fannie Mae. These companies sell your loan to investors. In such situations, the investors rather than the original lender receive compensation if you default on the loan. In contrast, portfolio loans are mortgages that a lender keeps in its own loan portfolio. The FHA doesn't insure portfolio loans, which means your lender assumes the risks associated with the loan.
Lenders generate money on FHA loans by selling them for profit to Freddie Mac, Fannie Mae and others. Your lender receives an upfront fee for the loan, but your future interest payments go to the purchaser of the loan. In contrast, your lender receives all of the interest payments you make on a portfolio loan. Therefore, a portfolio loan provides your lender with recurring income, while an FHA loan provides a lender with a one-off cash payment.
During a severe recession, high unemployment levels often lead to increased loan default rates. A lender with a large portfolio of loans may incur huge losses or even go bankrupt if enough people default on their loans. In contrast, lenders that write large numbers of FHA loans are less affected when foreclosure rates sky rocket. However, less risk also means limited long-term income. Therefore, most lenders offer a mixture of FHA and portfolio loans.
The FHA insures only those loans that fall within certain underwriting guidelines. Regional FHA offices set debt-to-income ratio limits. You can't get an FHA-backed loan if you spend too much of your income on debt payments. The FHA also imposes limits on the types of property that you can finance. With portfolio loans, each lender sets its own rules. Some lenders offer portfolio loans to people with poor credit scores while others don't verify your income. However, loose underwriting guidelines usually result in higher-than-average interest rates. If you work with a lender that offers both types of loans, you can weigh the pros and cons of each before making your final decision.