You’ve probably heard of the three C’s of credit; Character (Credit), Capacity, and Collateral (Capital). You also might be aware that most private lenders and note buyers ignore sound underwriting principals in order to get money out the door. They get so excited about a deal that they think from the heart and not with their head.
Character, sometimes referred to as credit, is a good example of “past predicts future.” Will the borrower forego eating and buying nice shiny things in lieu of paying their obligation to you? Obviously, there are exceptions to this rule, but if you see that borrowers have not paid their bills in the past, it’s a pretty good bet that they won’t pay you when the chips are down.
Most lenders simply focus on Collateral/Capital. They feel that if they are at the right loan-to-value that they can’t get hurt. Unfortunately, there are many ways that a borrower can hang you out to dry even though you are properly secured. Ignoring the character and capacity of a borrower can get your burned.
One radical take of our underwriting process is how we weigh the three C’s. A wise lender early in my career told me that the three most important things in lending are Ability, Ability, and Ability! In other words, Capacity. If a borrower doesn’t have the disposable, stable income to pay you back, you are sure to face problems. A borrower can overcome past credit issues and they can even pay when the lender goes over the appropriate LTV, but it’s really hard for them to pay their bill to you if they don’t have the income coming in to cover it.
Most lenders ignore the three C’s when underwriting a deal. Make it a practice to look at all phases of a deal before acting.
I hope I haven’t scared you away from entering or deepening your commitment to private lending or note buying. We’ve enjoyed tremendous success in the industry and we hope that you do as well. I simply implore you to truly think with your head and not your heart when making a deal. Take the time for follow sound underwriting principals. Develop relationships with successful, knowledgeable lending professionals and don’t be afraid to pick their brains about their best practices. If you simply hone your skills and adhere to a solid due diligence process, you too will be successful. Best of luck!