{"id":3643,"date":"2024-01-03T08:00:00","date_gmt":"2024-01-03T13:00:00","guid":{"rendered":"https:\/\/www.deeds.com\/articles\/?p=3643"},"modified":"2024-04-25T23:17:01","modified_gmt":"2024-04-26T03:17:01","slug":"whats-a-scratch-and-dent-mortgage","status":"publish","type":"post","link":"https:\/\/www.deeds.com\/articles\/whats-a-scratch-and-dent-mortgage\/","title":{"rendered":"What\u2019s a \u201cScratch and Dent\u201d Mortgage?"},"content":{"rendered":"\n
\"\"<\/figure>\n\n\n\n

Last year, mortgage lending slowed<\/a> to a crawl. So, the lending industry had some extra time on its hands. Fannie Mae and Freddie Mac took advantage of some of that extra time to go over the loans they purchased in the sizzling hot market of 2020-21. During those frenzied months, underwriters were under pressure to close high volumes of loans.<\/p>\n\n\n\n

When the dust settled, Fannie and Freddie found plenty of loans whose underwriters missed some things, perhaps not thoroughly checking the borrower\u2019s documents. These errors could lead to flawed estimates of a borrower\u2019s risk.  <\/p>\n\n\n\n

With nearly $10 trillion of loans issued in the hot market, the number with defects adds up to some $25 billion. Fannie and Freddie can\u2019t hold these bags. Their legal standards rule them out. So they send these hot potatoes back to the lenders.<\/p>\n\n\n\n\n\n\n\n

What Happens When Imperfect Loans Get Sent Back to the Originators?<\/h2>\n\n\n\n

First, the original lender needs to pay to reclaim these loans. Then, the lender does some repair work on the loans.<\/p>\n\n\n\n

In normal times, the value in such loans are discounted \u2014 around the 5%-off range. But today, these loans can be discounted by around 25%, which means taking losses of many tens of thousands of dollars per loan.<\/p>\n\n\n\n

Doing repair work on an imperfect loan (called \u201ccuring\u201d the loan in industry lingo) often means contacting the homeowner and persuading that person to do something. Maybe it means asking the homeowner to pay for more insurance coverage. Maybe the bank wants the homeowner to refinance into a picture-perfect loan. But interest rates shot up in 2023. Who wanted to refinance their home loans when interest rates spiked? It became unreasonable to ask homeowners to save the day for their lenders.<\/p>\n\n\n\n

At the end of the day, if the homeowner refuses the requests, the lender can\u2019t just force the change. That would offend consumer protection laws.<\/p>\n\n\n\n

And if the lender has no way to repair the errors, the loan simply will not be as valuable, because the homeowner is essentially keeping an erroneous discount on their monthly payments. That means investors aren\u2019t getting their optimal returns.  <\/p>\n\n\n\n

So, the loan will be harder for the lender to resell into the market. It winds up in the scratch-and-dent <\/em>(S&D) category. And that, dear readers, is how a market for S&D loans is made.<\/p>\n\n\n\n

A Market? Yes, People Invest in S&D Loans<\/h2>\n\n\n\n

Investing in mortgage loan notes is a thing. These are simply ordinary people\u2019s home loans. If you have a mortgage, and you\u2019re faithfully repaying the required portion with interest each month, then you have a performing <\/em>loan. That\u2019s the kind investors will pay the highest premiums for.<\/p>\n\n\n\n

But loans in the S&D category have some kind of issue. For these mortgage loans, the pool of willing investors is smaller. These loans could come with minor underwriting errors, as we\u2019ve described in the section above. Other possible defects could be:<\/p>\n\n\n\n