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The Role of Credit Scores in Mortgage Note Investing

by Alan Noblitt on January 6, 2012 · 2 comments

  

Any time that a mortgage note holder calls me about selling their note, one of my initial questions to them is regarding the credit score and current employment of the payer (the new owner of the property who is making payments on the note).  More often than not, the caller will have little or no idea about either one.  This use to frustrate me, as I could not imagine taking that large of a financial gamble without doing some basic homework first.  Sometimes, the holder of the mortgage note (a.k.a. real estate note) would say that if there ever was a default, then they would just take back the property and resell it.  In their naivety, they didn’t consider the time and expense of foreclosure, needed repairs to the property, or a multitude of other factors such as tax liens.

When evaluating a note, we consider not just the payer’s FICO score but their entire credit history.  Usually, the score and history match up.  However, there are times when a payer went through a divorce, medical procedure, or other major life event that temporarily limited the ability to pay their bills, but from which they have since financially recovered.

As I’ve stated in a previous blog, the two most important characteristics in our decision to buy a note are the amount of equity in the property and the credit of the payer.  If the equity is strong but the credit is weak, we can usually still buy the note, though we would buy just some of the payments (called a partial) or buy the full note at a bigger discount.  Excellent equity and credit are a note buyer’s dream.  If both are lacking, most investors will not be willing to pursue a note purchase, though we will sometimes make a small partial offer.

Neither we nor most other note investors ever buy a note with the hope or expectation that it will default.  We like to see those monthly payments come in.  That is why we are so careful to buy notes where the payer has the capacity and willingness to pay on the real estate note every single month.  Yes, we make sure that the collateral (property) backing up the note is solid, but hope that we never have to go down that road.

If you’re considering selling a property using owner financing, be sure to first check the credit of the buyers.  You may still decide to sell to a person with questionable credit, but would at least then have your eyes open to the possible risks.  You can check credit by signing up with a national credit reporting agency or just by contacting a local company.  Selling to an individual with good credit doesn’t guarantee that they will never default (a couple of my notes where the payer had great credit did go south and I had to foreclose), but at least lowers the probability by a wide margin.

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{ 2 comments… read them below or add one }

Kevin Kaczmarek January 9, 2012 at 10:29 am

excellent point Alan, and like you said, one often overlooked, including me in my early days of note origination and selling. Today if a buyer has a poor credit score and I am looking to buy the note, I essentially will buy it at a wholesale cash price of the underlying asset, knowing that the chance for default is much higher, especially in this economic climate where borrowers have less considerations to their lender.

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Alan Noblitt January 9, 2012 at 12:08 pm

Kevin,
Sounds like a good strategy. Thank you for the feedback.

Alan

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