The Importance of Documentation in Real Estate Credit Memos: A Comprehensive Guide

When it comes to real estate financing, documenting every aspect of the credit process is crucial for both lenders and borrowers. A well-documented credit memo can provide a clear understanding of the loan's terms, the borrower's financial situation, and the risks involved. In this article, we will explore the key elements that should be included in a real estate credit memo, including the importance of documenting cash flow, debt service coverage ratios, and credit history.

For purchase money loans, it is essential to document the purchase price and present loan-to-cost (LTC). This information helps lenders understand the relationship between the loan amount and the property's value. In addition, for real estate loans, the basis for the valuation should be noted to ensure that the value aligns with interagency guidance for real estate appraisals.

When a borrower defaults on their loan, it is necessary to document the asset's value and loan-to-value (LTV) ratio. This information helps lenders understand the level of risk involved in repossessing or selling the collateral. Furthermore, documenting cash held in the institution is critical, as it provides insight into the borrower's liquidity and ability to service their debt.

The credit memo should also include an analysis of the borrower's debt service coverage ratio (DSC). This ratio measures a borrower's ability to pay their debts, and lenders use it to assess the level of risk involved. A DSC ratio closer to 1.0x or higher indicates that the borrower has sufficient cash flow to service their debt.

In addition to the DSC ratio, lenders should also consider the debt-to-income (DTI) ratio, which measures a borrower's ability to pay their debts relative to their income. For consumer loans, it is common to calculate DTI considering current debt load, additional debt, and current earnings.

The credit memo should also document the borrower's cash flow, or earnings before interest expense, taxes, depreciation, and amortization (EBITDA), based on past 3-5 years of tax returns or financial statements. This information helps lenders understand the borrower's ability to generate income and service their debt.

Commercial loans generally utilize the DSC ratio, while consumer loans use the DTI ratio. Both ratios provide valuable insights into a borrower's creditworthiness and risk profile. By including these elements in the credit memo, lenders can assess the level of risk involved and make informed lending decisions.

Finally, the deposit history should be evaluated and included if the borrower has a history of overdrafts and NSF items. This information provides insight into the borrower's financial discipline and ability to manage their finances.

In conclusion, documenting every aspect of the credit process is crucial for real estate lenders. By including elements such as cash flow, debt service coverage ratios, and credit history in the credit memo, lenders can assess the level of risk involved and make informed lending decisions. With a well-documented credit memo, lenders can ensure that they are meeting regulatory requirements and monitoring credit risk effectively.

Real estate credit memo pdf