What is a Risk Rating?

A risk rating is a rating between F-A+ (A+ being the best possible rating) that is attached to every loan made on the Constitution Platform.

Categories of Risk that Make Up the Risk Rating

All risk ratings are calculated off the 7 items listed below:

  • Loan-to-Value Ratio

  • Location

  • Property Type

  • Borrower Assets

  • Borrower Credit Score

  • Personal Guarantee & Equity Pledge


Loan-to-Value Ratio

An LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage. For example, if you buy a home appraised at $100,000 for its appraised value, and make a $10,000 down payment, you will borrow $90,000. This results in an LTV ratio of 90% (i.e., 90,000/100,000). Determining an LTV ratio is a critical component of mortgage underwriting. Lenders assess the LTV ratio to determine the level of exposure to risk they take on when underwriting a mortgage.

Location

If a property is located in a core urban market and therefore might be sold quicker this reduces the risk of being stuck and unable to sell the property. If the property is in a more rural area there are typically less potential buyers and therefore the risk is increased.

Property Type

Unsurprisingly, certain property types are riskier to lend on. As an example, a single family home in an active real estate market is one of the safest property types to lend due to the fact that they can often be sold quickly and to several different potential buyers. Comparatively, a small industrial auto mechanic building has one specific type of buyer and harder to liquidate in the event of a default by the borrower.

Borrower Assets

Lending to a borrower that has significant assets outside of the property being lent on reduces the risk of the loan due to the fact that they have more assets that can be pledged or seized in the case of a default.

Borrower Credit Score

A borrower who through his credit history has shown that they are serious about paying their obligations is typically considered of lower risk than a borrower who has had trouble with debt repayment in the past. We are however open to lending to low credit score borrowers depending on the situation.

Personal Guarantee & Equity Pledge

A personal guarantee not only helps reduce the risk if the borrower has significant other assets, it's also a great way to make the borrower understand that they can not simply walk away from the property if something goes wrong.

An equity pledge is an agreement between a borrower and a lender. In the case of default, the lender can foreclose on the LLC interest that owns the property instead of directly foreclosing on the property thus circumventing the judicial foreclosure process. Typically this means a significantly faster principal payback process for investors.

We are currently the only platform to offer this protection for our investors.

Summary

An underwriter considers dozen of data points when choosing whether to make a loan and at what interest rate. This is not an exhaustive list, but it is a great place to start to understand what to look for when making a real estate loan investing decision. As always, if you ever have any questions give us a call or send us an email.

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