Qualitative criteria can provide borrower insights that quantitative data often don’t capture.

Small private lenders tend to have a different business model and deal flow than their larger counterparts. For example, smaller lenders tend to focus on a few geographical areas and know their markets well. Smaller lenders also develop deeper connections in the markets where they operate. Those connections can benefit borrowers when it comes to referrals and networking.

Small private lenders may have limited liquidity and tend not to sell their loans after origination. They have to be a bit choosier about the loans they make because they become the assets to their businesses. As lenders, they must be prepared to be involved in the relationship with their borrower for at least the maximum term of the loan, which could be anywhere from 6 to 12 months.

Since borrowers are the central component of the ecosystem for small lenders, how do smaller lenders successfully find great borrowers?

Some of the metrics that are most important are on the qualitative side, the ones you gain through genuine conversations with the borrower: What is their experience in that type of project? What expectations do they have for the transaction and project timeline? Do they take ownership for their actions and mistakes?

Borrower Experience

How do you evaluate borrower experience? What level of experience would you want as a lender? The range of acceptable answers is very case- and deal-specific.

The individual lender’s risk tolerance plays an important role in framing this conversation with the borrower. Lenders often evaluate experience based on how much history and time the borrower has with the type of project the loan being considered resembles. If the borrower seeks funding for a fix-and-flip but has owned only turnkey rentals, their schedule of real estate owned may be misleading, because it looks like they are an experienced investor. They may have five rental properties on their schedule of real estate owned; however, in a conversation with the borrower about their history with those properties, the lender could discover they have not had to manage a renovation project before the deal under consideration.

As a small lender, would you be willing to take on a first-time flip? The borrower may need more guidance than others (e.g., referrals to trustworthy vendors and reminders of how the construction draw process works).

On the other hand, a borrower that has executed at least a few renovation projects likely has a few battle scars and stories to tell about past experiences. The school of hard knocks has taught them a few things about renovations. The risk profile of a borrower who does 25 flips a year with their own contractor crew is very different from a borrower who is doing their first flip ever!

So, ask potential borrowers about their involvement with past properties, specifically what they did, who else participated in the project, and what they would do differently in the future.

Borrower Expectations

All private lenders have had borrowers that were overzealous and pinging for updates about their loan every hour. There are also borrowers who drop off the radar for weeks at a time and then show up two days before closing wondering why their loan hasn’t been approved yet.

Borrowers’ actions reflect their expectations. When lenders have the opportunity to get to know borrowers before the loan closes, they can determine whether the expectations match, are complimentary, or not even in the same ballpark.

You need to be clear about expectations set for how much capital a borrower is expecting to put into the project, when capital for renovations will be received, frequency and reasons for communication throughout the loan, the method and intervals for paying interest on the loan, and what may trigger a default in the loan. Establish your expectations as a lender early on to weed out borrowers that, realistically, won’t fit into your loan box at all. A borrower with expectations that are not in line with your own as a lender won’t be a good match for a loan for you to fund or they’ll become one of your problem files, eating up your time and energy over the life of the loan.

Another important aspect to gauge is the borrower’s expectations about the property’s timeline. The business plan for a borrower who expects to refinance or sell the property very quickly may be unrealistic, for example, if extensive renovations are required that could take several months.

Also find out how the borrower is planning to execute the work. Will they be doing a lot of the work themselves? Are they employed full time? If so, will this be a “nights and weekends” project? Do their costs and timeline include having a skilled, knowledgeable service provider complete the work, or are they going to get a “good deal from a friend of a friend”?

The expectations the borrower brings to the loan request will dictate the decisions and actions they take throughout the life of the loan, should you decide to fund it. Assessing whether those expectations are reasonable and accurate is crucial in deciding whether the loan will be successful.

Ownership of Actions

The “ownership of actions” screening is likely to be the most nuanced and subjective of the tools a private lender will use to assess a borrower. Usually only the smallest and most hands-on private lenders use it.

This criteria gauges how well a borrower will own up to the failures and successes of past deals. Does a borrower start explaining how a previous business partner led them astray and that’s why a previous project ended in a deed in lieu? Is every contractor in town a bad person? Do they blame the listing agent for not doing their job in marketing the property in their last flip, causing them not to hit the expected ARV?

Listen to what the borrower says and where they start placing blame. A strong borrower can own up to their actions. They say they chose the wrong business partner or didn’t hire the right contractor the first time. Or, they acknowledge the property didn’t appraise for as much as they thought it would and they’ve adjusted the evaluation criteria accordingly. These answers indicate a confident borrower who realizes they have control of their ecosystem and processes. The buck stops with them. When lending out your own capital, wouldn’t you want someone who takes ownership and feels like they can steer the ship?

Assessing how much responsibility a person takes for their actions isn’t quantitative. It will be a gut check for most people. This tool reveals mindset of a person—one that will ultimately guide them as they make decisions throughout the course of the loan. When things get tough, are they going to buckle down and get it done? Will they bury their head in the sand and pretend the problem isn’t there? A borrower with the mindset of owning up to their actions will likely be successful no matter what because they give themselves the power to fix the problem instead of relying on others to address it for them.

The more traditional criteria for lending—credit scores, liquid reserves, and income—are far easier to evaluate in the paperwork a lender collects from a borrower. Should considering those quantitative metrics be part of your own review criteria? Absolutely! Don’t replace them with the more qualitative factors addressed here; rather the qualitative criteria should be an adjunct to the traditional criteria.

Evaluating a borrower involves assessing the entire loan file, person, and property. Not all those evaluations can be completed with the information gathered through the typical documents involved in the loan origination and processing phases. Old-fashioned communication with a borrower can probably tell you more about them as a borrower and how they perceive their deal than reading through 30 pages of paperwork ever could. The real story is likely going to be a bit different from what the numbers, checkboxes, and words on a page tell you.