What’s Your Process for Stress-Testing a Note Deal?

Question

Do you run scenarios like payment drops, property value shifts, or tax issues?

Curious how others model risk before buying.

James Jones · Answer

Hey Barbara, good question, most people underwriting notes only look at yield, but the risk profile matters just as much. Here’s how I stress-test any note before I buy it.

1. Payment Shock Scenarios

I model three versions of incoming cash flow:

Base case: current payment schedule

Stress case: 3–6 months of non-payment

Severe case: 12+ months of non-payment and a full foreclosure timeline

Then I ask: Does my yield still make sense if the worst case hits?

If a deal only works when everything goes perfectly, I pass.

2. Collateral Protection & Value Shifts

Notes are collateral-backed, so I underwrite the property like I’m going to own it:

20–30 percent drop in value

Rehab cost increase

Longer days-on-market if I take the property back

If the only exit is foreclosure, I want to know I’m not inheriting a problem child.

3. Tax & Insurance Risk

Unpaid taxes or force-placed insurance can blow up your yield quickly.

I run scenarios where:

Taxes double (not uncommon in certain markets)

Insurance increases by 20–40 percent

Borrower stops escrowing

If any of that wipes out the yield, the deal is too tight.

4. Foreclosure Cost & Timeline

Every state is different, so I underwrite based on the actual jurisdiction:

Attorney fees

Court costs

Carry costs

Time until possession

Redemption periods

Then I build that entire expense stack into the model.

5. Yield Compression Scenario

Even great notes can turn into mediocre ones if exit timing shifts.

So I run a scenario where:

I hold longer than planned

I resell at a discount

My effective yield drops 2–4 percent

If I can live with that outcome, it’s a buy.

A good note deal is one where the worst-case scenario doesn’t put you underwater, and the base case gives you a comfortable yield.

Chris Seveney · Answer

Check out my response and then Note Investor group on BiggerPockets