Traditional mortgage providers take compliance and the ability to repay seriously — you should too.
Recently, I took and passed the SAFE Mortgage Loan Originator (MLO) Test. Included in that test is a required 20-hour NMLS pre-licensing education (along with your state’s required education).
It was eye-opening.
Working our quoting desk for the last three years, reviewing deals and learning from some of the best (shoutout Mom and Dad) certainly gave me a leg up and a great foundation. But working that quoting desk also gives me a front-row seat to some of the common mistakes in the world of seller financing, as well as to the important role it plays in mortgage lending.
Three Lessons from Getting My MLO
All loan packages in the traditional mortgage market are subject to strict regulations. Those rules are focused on protecting the lender AND the borrower, with many regulations passed after the 2008 mortgage meltdown.
Lesson #1 – Go Beyond the Credit Score
We see a lot about credit scores — and for good reason. They are a great insight into the borrower’s consistency.
But Ability-to-Repay (ATR) goes beyond that. It includes the borrower’s Debt-to-Income (DTI) Ratio. DTI, expressed as a percentage, is total monthly debt (rent/mortgage, auto loans, student loans, and minimum credit card payments) divided by gross monthly income. Note: DTI in this setting does not include standard living expenses like groceries, utilities, or insurance. It is what appears on your credit report.
For conventional mortgages backed by Fannie Mae and Freddie Mac, lenders generally look for a borrower’s debt-to-income ratio to fall between 36% and 45%.
The reason is simple: historical lending data has consistently shown that borrowers with manageable debt loads are more likely to make on-time payments and less likely to default.
It’s time for seller-financiers and investors to look beyond credit scores and do their homework to determine a borrower’s DTI.
Lesson #2 – Get the Down Payment
You’re going to hear me talk a lot about Freddie Mac and Fannie Mae. They are the two largest government-sponsored entities that back and purchase conventional mortgages. Their regulation dictate what conventional mortgages (which make up around 73% of all mortgages) from lenders require.
Including down payment requirements.
This is where you hear the common 20% down rule, which isn’t exactly the rule. Homebuyers can put only 3-5% down with conventional mortgages. BUT until they hit 80% LTV (reaching what would be 20% down), they are required to have Private Mortgage Insurance (PMI), which protects the lender in case the borrower defaults.
Now, PMI is not available on seller financing. That doesn’t mean you shouldn’t create a note or invest in a note if there isn’t a 20% down payment. It just means you need to offset it with good credit, strong ATR, and definitive proof of income.
Along with some form of down payment. In my experience review notes, a strong down payment can often compensate for other weaknesses, while little or no down payment usually means you need to look closer at the rest of the file…
Lesson #3 – Use an MLO and Servicer
All conventional loans are created in accordance with all federal and state regulations and are serviced.
While Seller-Financing is not subject to as many legal regulations, there is one major one we see overlooked: Dodd-Frank. One way to help notes comply is to work with a Mortgage Loan Originator. As MLOs, it’s the job to ensure that a mortgage loan meets all required requirements and is legally acceptable. And trust me — there are a lot of rules. It’s not an “I’ll give-it-a-go scenario.
Next, use a servicer. All conventional loans are serviced, and after going through the MLO training, it’s easy to see why. Good records matter. Servicing companies track payments, provide statements, maintain documents and create an independent record of the loan. That’s valuable for the lender, the borrower — and future investors.
Where Does Seller Financing Fit In?
Seller financing offers an opportunity.
Many traditional lending guidelines exclude a large number of reliable borrowers. Without a strong W2, like self-employed individuals, cash-based workers, those with difficult to verify income or a spotty credit history, like those with sudden changes in income or medical emergencies, or those looking in rural areas — it offers them a chance to own a home.
More than that, it offers the lender, the person offering seller-financing, interest income and access to a larger pool of borrowers.
Completing the training and examination for an MLO license supported what I already noticed — many note creators and investors are too lax. While following compliance rules is important, take the steps banks take to protect your borrowers, collateral, and investment.
Want to learn more about Creating Notes? Check out our Creating Notes Master Class.
Mikayla,
First off, congratulations on your certification!
Secondly, is there a list of investor friendly MLO’s on the site?
And thirdly, this could be an idea for a future podcast or mastermind session -common mistakes when creating a note.
Hi John!
Thank you!
We have a yearly Best of Notes that let’s folks vote on their favorite companies and resources in the Note Industry, including their favorite Mortgage Loan Originators. You can check that out with last year’s winners and nominees at https://noteinvestor.com/best-of-notes/.
We love that idea! Thanks for passing that along. We do have two related articles at https://noteinvestor.com/notes-101/wrap-note-mistakes/ and https://noteinvestor.com/sellers-corner/seller-financing-mistakes/.
Have a great week!
So, let’s create our own mortgage insurance company!
I like this article about mortgage creating and compliance…
This is accurate but exaggerated.
For example, ” use a servicer. All conventional loans are serviced, and after going through the MLO training, it’s easy to see why. Good records matter. Servicing companies track payments, provide statements, maintain documents and create an independent record of the loan. That’s valuable for the lender, the borrower — and future investors:”
Reality – Note servicers suck! No one is going to care about YOUR NOTE as much as you. Service your own notes. software’s to do this are cheap. And you get the not only keep the late fees but also demand letter fees.
Plus, you are on top of your money.
Hi Yoander! Thanks for sharing your perspective. There are certainly investors who successfully service their own notes, and you’re right that no one is likely to pay closer attention to your investment than you do.
For many investors, the decision comes down to balancing control with documentation and administration. A good servicing company can provide payment tracking, statements, escrow administration (when applicable), and an independent record of the loan’s performance. That can be particularly valuable when a note is sold, inherited, or if a payment dispute arises.
It’s also worth noting that self-servicing may not be permitted in every situation or every state, so investors should understand the laws, regulations, and licensing that apply to their specific transaction before deciding how a note will be managed.
Like many things in note investing, there isn’t a one-size-fits-all answer. Some investors prefer to self-service, while others prefer to outsource some of the administrative responsibilities. The important thing is that the note is managed professionally, legally, and with accurate records.
Thanks again for adding to the discussion.
Great article Mikayla! Congratulations on passing your exam. I hope everyone reads this article. Seller financed loans are all the more valuable when the file is properly underwritten and servicing records along with payment history and conversation logs exist.
I agree that credit report is not the only thing to look at when evaluating a borrower’s ability to pay. One thing I observe time and again is that many investors are desperate and will accept a small down payment even if the DTI ratio is really high.
Using a MLO comes with an expense but the risks that investor take might be higher without one.
Thanks Sadhna – a course and process you know very well! That’s a great observation, thanks for sharing!
Yes! 100%! As a former MLO, I regularly use these lessons in both our note business and our lease option business. I often tell people “there’s more to your credit than your score. I want to know the back story.”
Love that – tell me your story!
Great article. Congrats on your MLO Mikayla!
Thanks Eddie! It was a great course – lots of information that’s helpful beyond even mortgages and real estate.
Thanks for your helpful article as it regards to buying notes as that is what we do. Could you please expand on your comment “definitive proof of income” as to ways this can be done when vetting the note borrower.
Hi Tim. Great question! When it comes to getting proof of income when creating a seller-finance note it is common to request:
a. Self Employed: 2 previous years of tax returns or 12 months of current bank deposits.
b. W2 wage earner: Last two years of W-2s and 2 current pay stubs
c. Pension/SSI/Disability etc.: 1099 or current award letter
If you are buying an existing note you can ask for the note seller to provide copies of documentation in their collateral file. If they did not obtain then it is an issue of evaluating the risk and exposure. Thanks!