Scratch and dent loans sound like financing that’s been through a lot, but they’re actually less terrifying than they sound. Scratch and dent loans are mortgage loans that have defects or irregularities that make them difficult to sell through normal secondary mortgage market channels. The term comes from retail merchandise that is still usable but is sold at a discount because of minor damage or imperfections. In mortgage lending, a loan may be considered “scratch and dent” because of problems with its documentation, underwriting, appraisal, borrower information, regulatory compliance, or other aspects of the origination process. For example, a loan might contain a missing document, an underwriting exception, or another defect that prevents it from meeting the purchasing requirements of an agency or institutional investor.
Scratch and dent loans are often sold by lenders to specialized investors at a discount from their outstanding principal balance. The size of the discount generally depends on the seriousness of the defect and the risk associated with the loan. Some defects can be corrected or “cured,” potentially making the loan easier to resell later, while others may permanently limit its marketability. Importantly, a scratch and dent designation does not necessarily mean that the borrower is delinquent or that the property is distressed. The term primarily describes a problem with the loan’s eligibility, documentation, underwriting, or compliance rather than the borrower’s payment performance.
Scratch and Dent Loans
