This is a transcription of part five of our video series, Investing Mortgage Notes. In this video, we discuss how to underwrite a mortgage note and determine its value.

Welcome back to the fifth in our series of podcasts regarding mortgage notes and investing in them. Today we’re going to be talking about how to underwrite a mortgage note and determine if it’s a good one or not, or bad, and thus we shouldn’t invest in the bad ones.

Mortgage Note Underwriting

So the first thing that we really look at with our underwriting is the borrower’s payment history. As I think I’ve mentioned before, we only buy seasoned notes that have first trust deeds against them and are hopefully very conservative. In so doing, we want to make sure that a borrower has been paying consistently during, whatever the term of the loan has been.

homes and mortgage note underwriting

Now, the Mortgage Bankers Association tells us that 80% of all defaults happen within the first two years of the mortgage loan. So if you think about that and do the math, if you wait at least two years, you’ve gotten rid of at least 80% of the risk, the broad risk anyway, regarding your particular note purchase. Plus you’ve got the other mitigating factors that we have spoken of in the previous issues of this series. So it tends to make them a fairly safe, a relatively safe investment.

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Borrower’s Payment History

So we’re always looking at the borrower’s payment history. We want to underwrite the borrower accordingly. We want to make sure he’s got a good credit rating, a decent job, things of that sort. And I should tell you that a lot of people who live in these homes are everyday people. He maybe a school teacher and maybe she’s an accountant or works for some local company, and they’re just making their lives the way the rest of us all are. They’re probably not in the top 1%, but they’re perfectly lovely people and certainly good credit risks.

So we underwrite their credit, we underwrite their payment history. We also look at the location of the property, when I say location, I don’t mean Gee, where is it in relationship to the downtown and school districts and things like that. That can be important, but mostly what I’m looking for is jobs and I want to see what the demographics of the area are. Is this a city that’s losing population or stable or gaining population? Is it a city that is completely dependent on one industry? There are a lot of little towns that get wiped out because they were somehow dependent on the auto industry before the recession. Maybe their town was a large producer of bumpers or steering wheels or whatever it was, but that was the leading industry in their city.

And when the recession came along and they get wiped out because they had been working on the line for 15 years or however long, and it was very difficult to find something else because A, they needed to be retrained and B, there just wasn’t that much out there. So we tend to look for economies that have that are diverse in terms of jobs, and always they have a number of job offerings. So if somebody did lose their job, you can always hope that they could find another job someplace else. We look at the local market in terms of houses, are houses appreciating or depreciating? What’s the local crime rate? Is it something, a place where we would all want to live or not? We always try and go for the lowest crime rate. Occasionally you can find a home that’s still perfectly good investment, that’s in an area that’s a little bit fringier, but we tend to stay away from those.

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And you have to think about a lot of these towns that we invest in, say if you went to Indianapolis or St Louis, they certainly have their bad areas where you wouldn’t want to invest. But they also tend to be just pretty nice, stable communities where jobs can be found and there’s nice tree lined streets and nice neighborhoods.

One other thing that we always want to try to ensure, believe it or not, is that there is a Walmart a within 10 miles. The Walmart rule is sort of curious, but Walmart does a lot of research regarding the demographics and the purchasing power in a specific area before they decide to put a Walmart in a given community. And there’s always just a little bit of assurance that if you’re within 10 miles of a Walmart, that they feel anyway, that the job area is diverse enough to support one of their stores, and their stores are pretty big. So if you think about it, that’s a lot of purchasing power.

So, that is a summary, overall, there are a number of other factors that we also look at, but those are the big ones and the biggest one being the borrower’s payment history. I did forget to mention, I’m sorry, the actual physical building itself. We want to look at the condition of the property, is it in good condition? Poor condition? Does it need repairs? What’s the foundation like? We have the title run on all of these so that we are sure that we’re getting something that we can have title to, clear title to. But we want to make sure it’s a good piece of property all the way around. So that’s how we generally underwrite.

As we said before, if you have immediate questions, please don’t hesitate to give me a call. I’m Richard Thornton, I can be reached at (510)918-9001. And if you would like to get more information, please feel free to watch the sixth episode of this series. See you then.

Missed our previous installments of this series? Click the links below to view them.

Part 1: Investing in Mortgage Notes
Part 2: Notes Vs. Deeds, Land Contracts, and Subprime Mortgages
Part 3: Buy & Broke Mortgage Notes
Part 4: Alternatives to Investing in Mortgage Notes