For Note Investors: What’s Your Ideal Borrower Profile?

Question

I’m refining my due-diligence criteria and realized everyone weighs borrower traits differently.

Some prioritize credit score, others payment history, employment stability, or equity position.

Curious what traits matter most to you when evaluating a borrower behind a note.

Doug Smith · Answer

35-year lender here with a formal credit background and thousands of loans underwritten...also started running a note fund and this company during the last crash. First, what is your goal? Are you buying loans with the idea that they will pay you back or are you buying NPLs on abandoned property as a quasi-real estate play? Those are two totally different animals. From the context of your question, I am assuming you wish for the loans to perform. You can't just look at one thing and there is no way for me to adequately answer this in a sound bite, but you start with "The 3 Cs of Credit": Capacity, Character, and Collateral. Personally, I think the most important is Capacity (not to diminish the other two...they are important too). Does the client have the ability to pay you back should things get rough for them. Is their income sufficient and stable to provide a reliable primary source of repayment? Character, or credit as some call it, is the concept that "past predicts the future". A leopard doesn't change it's spots. If a client is not carrying heavy debt and has shown a propensity to pay their bills when the chips are down, they are a much better risk than someone who overextends themselves then cuts and runs. Collateral is your tertiary form or repayment. If all else fails, is the collateral something that can be easily foreclosed upon and easily liquidated in order to cover the debt? Keep in mind the State you're buying in. Deed-theory states like MO are quick to foreclose in while Lien Theory States like NY are much slower and more difficult. You have to factor that in to your analysis. Once again, this isn't something I can answer or teach in a sound bite like this. Hopefully that at least provides you food for thought. Good luck to you.