Types of Mortgage Loan Defects
Not all Scratch and Dent loans are created equal. Understanding the specific type of “dent” is critical to pricing the asset and determining your exit strategy. Defects fall into three distinct categories.
Document Flaws
Administrative or compliance errors made by the title company, loan officer, or underwriter.
Payment Gaps
Borrower-driven issues where payments were missed early in the loan’s life.
Guideline Misses
The borrower’s financial profile falls just outside strict secondary market parameters.
Document Flaws
Often the most profitable loans to acquire because the borrower is usually paying perfectly — the flaw is purely on paper. Examples include missing signatures, improperly recorded deeds of trust, lost appraisal files, or failure to provide specific regulatory disclosures. These are highly curable.
Payment Gaps
The most common is the First Payment Default (FPD) — the borrower closes on the home but misses the very first mortgage payment. Even if they catch up and pay perfectly for the next 6 months, the secondary market will not buy the loan. This is often a temporary hurdle (job transition, medical event) rather than a systemic inability to pay.
Guideline Misses
Fannie Mae has strict boxes. If a borrower’s DTI is too high or their credit score dropped 5 points below the threshold right before closing, the loan becomes non-conforming. It is a perfectly good loan to a solid borrower — it simply doesn’t fit the GSE box.
The Strategy: By analyzing the data tape and identifying the specific defect code, investors can target the exact types of “dents” they are best equipped to cure.