Credit & Lending

How to Underwrite a Loan or Note Purchase

Underwrite a loan or note purchase by confirming you can legally enforce it, then pricing it on expected cash flows given borrower payment behavior and collateral value. Key metrics are payment history, current collateral value and loan to value, lien position, unpaid principal balance versus purchase price, and projected timeline and cost to resolution for sub-performing or defaulted notes.

What makes loan / note purchase underwriting different

Buying a loan or note means stepping into the lender's shoes. The buyer receives the borrower's payments or, if the loan defaults, the right to enforce against collateral. Value depends on whether the borrower keeps paying, the value and lien priority of the collateral, and the cost and time to resolve problems. Performing notes trade like fixed income on yield. Sub-performing and non-performing notes trade at discounts to unpaid balance and are priced on expected recovery. Risk comes from defects in the note file, such as missing assignments or endorsements, servicing errors, borrower defenses, bankruptcy, and local foreclosure timelines that can stretch for years.

Lenders who finance note purchases advance against the lower of purchase price or a percentage of collateral value, and they require clean collateral files, servicing by a licensed servicer and concentration limits. Equity buyers underwrite the spread between purchase price and expected recovery. For performing loans they model yield and prepayment. For non-performing loans they model resolution paths, including loan modification, discounted payoff, deed in lieu, foreclosure and REO sale, each with its own timeline, cost and recovery. Servicer quality is critical either way.

Key metrics

Payment history

Recent payments show borrower willingness and ability to pay, which drives whether the note is valued as performing or on recovery.

Buyers commonly treat a note as re-performing only after a sustained run of on-time payments, often twelve months or more.

Loan to value

Collateral value relative to unpaid balance determines recovery if the borrower defaults.

Lien position

First liens have priority, while junior liens may recover little if a senior lender forecloses.

Purchase price to UPB

The discount to unpaid principal balance sets the potential return and margin for error.

Time to resolution

Foreclosure and bankruptcy timelines affect carrying costs and IRR.

Expected recovery net of costs

Legal, servicing, taxes, insurance and property costs reduce net proceeds.

How to underwrite it, step by step

Review the loan tape and collateral file for each note, including original note, mortgage or security agreement, endorsements and assignments.
Verify payment history and servicing records, and confirm escrow balances and advances.
Obtain updated collateral valuations such as broker price opinions or appraisals.
Confirm lien position, title, senior liens and outstanding property taxes.
Assess borrower status, including bankruptcy filings, litigation and contact history.
Model resolution paths and cash flows with jurisdiction-specific foreclosure timelines and costs.
Price the note to target return, adjusting for document defects and servicing risk.
Arrange servicing transfer, borrower notices and representations and warranties in the purchase agreement.

Due diligence checklist

Original promissory note with endorsements or allonges
Mortgage, deed of trust or security agreement
Assignment chain and recording information
Loan payment history and servicing notes
Title report and lien search
Broker price opinion or appraisal
Property tax and insurance status
Bankruptcy and litigation searches
Loan modification and forbearance agreements
Loan sale agreement with representations and repurchase obligations

Key risks and mitigants

Defective collateral file

Review originals, require cure or repurchase rights and price in the cost of curing defects.

Collateral value decline

Use conservative valuations and require adequate equity cushion.

Extended foreclosure timeline

Model jurisdiction-specific timelines and include carrying costs in pricing.

Borrower bankruptcy

Search bankruptcy records, model cramdown or delay scenarios and price accordingly.

Servicing errors or compliance violations

Use licensed servicers, review servicing history and require seller representations.

Typical financing and deal structure

Note buyers often finance purchases with repurchase facilities or warehouse lines from banks and specialty lenders, which advance a percentage of the lower of purchase price or collateral value. Performing loan pools can be securitized once seasoned. Non-performing notes are usually purchased with equity or limited leverage given uncertain cash flows. Joint ventures between capital providers and note specialists are common, with preferred returns and promote structures. Loan sale agreements include representations about the collateral file and loan origination, with repurchase obligations for breaches. Lenders require licensed third-party servicing, collateral custody and concentration limits by state and loan type.

Red flags

Missing original note or broken assignment chain
Collateral value below the senior lien on a junior note
Borrower in active bankruptcy with an unfavorable plan
Servicing records with gaps or unexplained fees
Property in a jurisdiction with long foreclosure timelines and low recovery

Frequently asked questions

How do you price a non-performing note?

Non-performing notes are priced on expected recovery rather than the unpaid balance. Buyers estimate collateral value, resolution path, timeline and costs, then discount expected net proceeds at a target return. Lien position, borrower status, jurisdiction and the condition of the collateral file all affect price. Most buyers model several resolution scenarios and weight them by likelihood.

What is the difference between performing and non-performing notes?

Performing notes have borrowers making regular payments and are valued mainly on yield. Non-performing notes are in default, and their value depends on recovery through modification, payoff or foreclosure. Sub-performing notes fall between, with irregular payments. Pricing and risk differ significantly, so buyers analyze each category separately within a pool.

What should be in a note due diligence file?

A complete file includes the original promissory note with endorsements, the security instrument, assignments, title report, payment history, servicing notes, collateral valuation, tax and insurance status, and any modification agreements. Missing documents can impair the ability to enforce the note, so buyers review files carefully before closing.

Can you finance a note purchase?

Yes. Buyers commonly use repurchase facilities or warehouse lines that advance a percentage of the purchase price or collateral value. Lenders require custody of collateral files, licensed servicing and eligibility criteria. Financing is easier to obtain for performing notes than for non-performing notes, which often require more equity.

Underwrite a loan / note purchase deal in minutes

Drop a deck or data room. Underridge returns a verdict, investment memo, term sheet and a live model, with every headline figure traced to a page, a formula or a labeled assumption. Ten underwrites free.

Try Underridge free

Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.