Private mortgage lenders who misread capital cost terms set rates that erode returns before the first payment arrives. This glossary defines the 18 terms that drive loan pricing, capital structure decisions, and servicing economics — plain language, no hedging.
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Understanding these terms is the foundation of what our pillar on unlocking the true cost of private mortgage capital addresses in full. Whether you are evaluating a new note acquisition, structuring a fund, or reviewing your servicing economics, these definitions give you the operational vocabulary to make accurate decisions. For a deeper look at where hidden costs accumulate, see our companion piece on optimizing capital and uncovering hidden costs in private mortgage servicing.
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| Term | Category | Why It Matters to Private Lenders |
|---|---|---|
| Cost of Capital | Foundational | Sets the floor for every rate you charge |
| WACC | Foundational | Blended benchmark for new deal evaluation |
| Equity Capital | Capital Structure | Foundational backing; dilutes if overused |
| Debt Capital | Capital Structure | Leverage amplifier; introduces covenant risk |
| Risk-Weighted Assets | Portfolio Risk | Determines real capital needed per loan type |
| Loan Servicing Costs | Operational | MBA benchmark: $176/yr performing, $1,573/yr non-performing |
| Opportunity Cost | Decision Economics | Invisible cost of every capital allocation |
| Default Cost | Risk | $50K–$80K judicial; under $30K non-judicial |
| Yield Spread | Pricing | Gap between your cost of funds and note rate |
| Capital Requirements | Compliance | Regulatory buffer against portfolio losses |
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What Is the Cost of Capital — and Why Does It Set Your Rate Floor?
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The cost of capital is the minimum return your money must earn to justify its deployment. Every rate you charge on a private mortgage note must clear this threshold before profit begins.
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1. Cost of Capital
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The minimum rate of return any new loan or investment must generate to maintain portfolio value and justify the capital deployed. It is the rate floor beneath every pricing decision you make.
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- Calculated as the blended cost of all funding sources — personal equity, LP contributions, credit lines
- A note yielding less than your cost of capital destroys value even when payments arrive on time
- Servicing inefficiencies inflate the effective cost of capital by adding untracked operational expense
- Lenders who skip this calculation set rates by market feel rather than financial logic
- Accurate cost-of-capital tracking is the first step toward defensible fund reporting
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Verdict: Know this number before quoting a single rate. Everything downstream depends on it.
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2. Weighted Average Cost of Capital (WACC)
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WACC blends the cost of every funding source — debt and equity — weighted by its share of the total capital stack. It is the single benchmark against which new deal returns are measured.
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- Formula: (Equity % × Cost of Equity) + (Debt % × After-Tax Cost of Debt)
- A deal returning less than WACC is a value-destroying deal, regardless of how the rate looks on paper
- Shifts in your debt-to-equity ratio change WACC immediately — monitor it at each capital raise
- Institutional note buyers use WACC to evaluate the portfolios they acquire; know yours before listing
- WACC calculations require accurate servicing cost data to be meaningful
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Verdict: WACC turns abstract capital structure into a practical deal-screening tool.
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How Does Capital Structure Affect Private Mortgage Returns?
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The mix of equity and debt in your capital stack directly determines your WACC, your risk exposure, and the returns available to equity holders. Getting the structure wrong compounds with every new loan originated.
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3. Equity Capital
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Funds contributed by owners, partners, or investors in exchange for an ownership stake — no fixed repayment schedule, no interest expense, but profit-sharing obligations.
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- Forms the solvency buffer that debt lenders and regulators examine first
- Dilutes existing ownership when new equity is raised to fund growth
- Heavy equity reliance lowers WACC but limits leverage and deal velocity
- Equity investors expect returns commensurate with their risk — document those expectations clearly
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Verdict: Equity is the safest funding source and the most expensive over time. Balance it deliberately.
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4. Debt Capital
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Borrowed funds — from credit lines, warehouse lenders, or private backers — that carry repayment obligations and interest charges regardless of portfolio performance.
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- Leverage amplifies equity returns when loan yields exceed the cost of debt
- Loan covenants in debt facilities restrict operational flexibility — read them before you draw
- Interest rate risk on floating-rate credit lines erodes yield spread when rates rise
- Lenders operating in the $2T private lending market increasingly layer debt sources to optimize WACC
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Verdict: Debt is a return amplifier with a compliance tail. Manage covenant risk proactively.
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Expert Perspective
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From where we sit as a servicer, the single most common capital cost error we see is lenders treating servicing as a fixed, negligible line item. It is not. The MBA’s 2024 data puts performing loan servicing cost at $176 per loan per year — and non-performing loans at $1,573. When a performing portfolio tips toward delinquency, servicing cost alone jumps nearly 9x. That swing is a capital cost event, not just an operational inconvenience. Lenders who board loans professionally from day one keep that number at the performing end of the range. Those who self-service until something breaks pay the non-performing premium at the worst possible moment.
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What Are Risk-Weighted Assets and Why Do Private Lenders Need to Understand Them?
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Risk-weighted assets assign a capital cost multiplier to each loan type based on default probability. First-lien performing notes carry lower weights than subordinate or non-performing positions — meaning they require less capital to support the same face value.
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5. Risk-Weighted Assets (RWA)
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A measure of portfolio assets adjusted by risk multipliers to determine the true capital buffer required. Higher-risk loans demand more capital per dollar of face value.
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- Performing first-lien mortgages carry lower risk weights than second-lien or non-performing notes
- RWA calculations directly affect how much new lending capital you can deploy from a fixed equity base
- Investors and institutional buyers use RWA logic when pricing portfolio acquisitions
- Accurate loan-level data from a servicer makes RWA reporting faster and audit-ready
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Verdict: Optimize your portfolio’s risk weight profile to deploy more capital from the same equity base.
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6. Capital Requirements
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Minimum capital thresholds set by regulators to ensure lenders and servicers can absorb losses without failing. These are not optional — they are the baseline for operating legally.
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- Requirements vary by state charter, license type, and portfolio size — confirm current thresholds with counsel
- Insufficient capital triggers regulatory enforcement actions before borrowers feel any impact
- CA DRE trust fund violations were the #1 enforcement category in the August 2025 Licensee Advisory — capital and trust account management are linked
- Accurate servicing records support capital adequacy reporting without manual reconciliation
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Verdict: Capital requirements are a compliance floor. Staying above them is cheaper than the alternative.
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What Do Loan Servicing Costs Actually Include?
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Loan servicing costs cover every administrative function that occurs after origination — payment processing, escrow management, borrower communications, tax and insurance tracking, and default procedures. They are recurring, unavoidable, and frequently underestimated.
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7. Loan Servicing Costs
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The ongoing operational expenses of managing a mortgage loan from post-origination through payoff or disposition. MBA 2024 benchmarks: $176/loan/year performing, $1,573/loan/year non-performing.
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- Escrow mismanagement alone triggers regulatory penalties and borrower disputes — see how escrow drains working capital for private lenders
- Self-servicing lenders routinely undercount labor, software, and error-correction costs
- J.D. Power’s 2025 servicer satisfaction score hit an all-time low of 596/1,000 — poor servicing carries reputational and legal risk
- Professional servicing transfers these costs to a fixed, predictable line item — no surprise labor spikes
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Verdict: Servicing costs are not optional overhead — they are a defined capital cost that belongs in every loan pricing model.
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8. Default Servicing Costs
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The incremental costs triggered when a loan enters delinquency or foreclosure — legal fees, property preservation, timeline carrying costs, and loss mitigation labor.
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- Judicial foreclosure: $50,000–$80,000 in direct costs; ATTOM Q4 2024 puts national average timeline at 762 days
- Non-judicial states: under $30,000 and significantly shorter timelines
- Every month of foreclosure delay is a month of carry cost, tax accrual, and insurance exposure
- Early default intervention — workout negotiations, payment plans — is measurably cheaper than full foreclosure
- Lenders without a default servicing workflow absorb these costs reactively rather than managing them proactively
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Verdict: Default is the single largest capital cost event in private lending. Build the cost into your pricing model before it happens.
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How Do Pricing Terms Translate Into Real Yield?
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Rate, yield, and spread are related but distinct. Confusing them produces loans that look profitable at origination and underperform at exit.
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9. Yield Spread
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The difference between the rate charged to the borrower and the lender’s cost of funds. Yield spread is the gross profit margin of a private mortgage note before servicing costs, origination expenses, and defaults are subtracted.
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- A 200-basis-point spread sounds healthy until servicing costs, origination fees, and default reserves are deducted
- Spread compression — when cost of funds rises faster than market rates — erodes profitability without changing the note rate
- Tracking spread at the loan level, not just the portfolio level, reveals which deal types actually produce margin
- See how servicing fees impact private mortgage capital for a full breakdown of what erodes spread
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Verdict: Yield spread is gross margin. Net margin requires subtracting every operational and default cost.
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10. Origination Costs
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All expenses incurred to close a new loan — underwriting labor, title work, appraisals, legal review, and broker fees. These costs reduce the effective yield on every note from day one.
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- Origination costs are a one-time capital outflow that must be amortized across the expected loan life
- Short loan terms amplify origination cost impact — a 12-month bridge loan absorbs full origination cost in one year
- Brokers and referral fees are often underweighted in cost models — include them explicitly
- Review the invisible costs of private loan origination for a complete line-item breakdown
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Verdict: Origination costs reduce yield from the first day of the loan. Model them before committing capital.
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11. Opportunity Cost
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The return foregone by deploying capital into one loan instead of the next-best alternative. It is always present, never appears on a ledger, and consistently underweights in lender decision-making.
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- Capital locked in a non-performing note has an opportunity cost equal to the yield on a performing alternative
- Slow default resolution compounds opportunity cost — every additional foreclosure month is a missed deployment month
- Efficient servicing reduces the time capital is idle or trapped in workout — this is a real return improvement
- At $2T AUM and 25.3% top-100 volume growth in 2024, the private lending market offers enough deal flow to make opportunity cost calculations meaningful
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Verdict: Opportunity cost is invisible on your P&L and visible in your long-term returns. Account for it in every hold-versus-exit decision.
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What Portfolio-Level Terms Affect Capital Allocation Decisions?
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Individual loan economics aggregate into portfolio-level metrics that determine whether a lending operation grows, stalls, or contracts. These terms govern that aggregation.
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12. Loan-to-Value Ratio (LTV)
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The ratio of the loan amount to the appraised or purchase value of the collateral. LTV is the primary leverage and risk metric in private mortgage underwriting.
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- Higher LTV loans require more capital reserves to cover loss severity in default scenarios
- LTV at origination is not the same as LTV at default — property value changes alter the equation
- Lenders pricing at the margin of their LTV tolerance leave no buffer for appraisal variance or market decline
- First-lien positions at conservative LTVs carry the lowest risk weights and the most favorable capital treatment
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Verdict: LTV is a risk dial. Turn it up for yield; turn it down for capital efficiency. Know which you are choosing.
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13. Debt Service Coverage Ratio (DSCR)
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For income-producing property loans, DSCR measures whether the property’s net operating income covers the loan payment. It is the cash-flow underwriting counterpart to LTV’s collateral underwriting.
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- DSCR below 1.0 means the property does not cover its own debt — a default risk indicator, not just a pricing variable
- Business-purpose private loans on rental properties rely heavily on DSCR to justify underwriting decisions
- DSCR deterioration during a loan’s term is a default early-warning signal that active servicing can detect
- Investors evaluating note portfolios use DSCR distributions to assess credit quality
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Verdict: DSCR tells you whether the deal works on the borrower’s cash flow, not just on your collateral.
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14. Net Interest Margin (NIM)
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The difference between interest income earned on loans and interest expense paid on funding sources, expressed as a percentage of earning assets. NIM is the efficiency measure of a lending operation’s core economics.
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- NIM compresses when funding costs rise faster than portfolio yields — a real risk in rising rate environments
- Operational costs subtract from NIM to produce the net return available to equity holders
- Servicer efficiency directly affects NIM — high servicing cost operations see narrower effective NIM
- Monitoring NIM at the portfolio level surfaces repricing needs before they become margin problems
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Verdict: NIM is the lender’s operating margin. Protect it from both funding cost increases and servicing inefficiency.
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15. Liquidity Premium
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The additional yield required by investors to hold an asset that cannot be quickly converted to cash without significant price concession. Private mortgage notes carry a liquidity premium over publicly traded instruments.
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- Professionally serviced notes with clean payment histories command lower liquidity premiums on resale
- Notes without servicer documentation face steeper discounts — buyers demand compensation for diligence uncertainty
- Fund managers with LP redemption obligations must price liquidity premium into their portfolio construction
- The secondary note market prices liquidity premium implicitly — it shows up in yield-to-price negotiations
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Verdict: Reduce your liquidity premium by maintaining pristine servicing records. It pays at exit.
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16. Loan Loss Reserve
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Capital set aside to absorb expected losses from borrower defaults. A properly funded loan loss reserve prevents default events from triggering a liquidity crisis.
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- Reserve adequacy depends on portfolio LTV distribution, borrower credit profile, and geographic concentration
- Underfunded reserves force asset sales at distressed prices to cover losses — the worst outcome for equity holders
- Regulators and institutional investors both examine reserve methodology during audits and due diligence
- Accurate default servicing data from a professional servicer informs reserve adequacy calculations
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Verdict: Loan loss reserves are not a cost — they are capital allocation to a known risk category. Fund them deliberately.
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17. Capital Recycling Rate
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The speed at which repaid or sold loan capital is redeployed into new originations. Higher recycling rates multiply effective portfolio yield without raising additional capital.
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- Payoff processing delays — a servicing function — directly slow capital recycling
- Non-performing loans with 762-day average foreclosure timelines (ATTOM Q4 2024) lock capital for over two years
- Efficient servicers process payoffs and releases faster, returning capital to the origination pipeline sooner
- Capital recycling rate is a competitive advantage in high-volume private lending operations
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Verdict: Recycling speed is a yield multiplier. Servicing efficiency is the operational lever that controls it.
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18. Effective Annual Rate (EAR)
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The actual annual return on a loan after compounding, fees, and timing adjustments — as opposed to the stated nominal rate. EAR reveals whether a loan structure performs as modeled.
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- Points charged at origination increase EAR above the stated note rate — factor them into pricing comparisons
- Early payoffs reduce EAR on point-heavy loans — model multiple payoff scenarios before closing
- Borrowers and lenders both benefit from clear EAR disclosure — it reduces disputes and supports regulatory compliance
- TILA disclosure requirements for consumer fixed-rate mortgages mandate EAR-equivalent APR disclosure
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Verdict: EAR is the honest version of your return. Use it to pressure-test every loan model before funding.
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Why This Matters: Vocabulary Is Not Academic — It Is Operational
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Private mortgage lenders who cannot distinguish yield spread from net interest margin, or loan loss reserve from capital requirement, price loans by intuition rather than analysis. That gap shows up in returns, in regulatory exposure, and in the valuation discount applied when a portfolio goes to market.
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Every term in this glossary maps to a decision point: how to price a new note, how much capital to hold in reserve, when to sell versus hold, and how to evaluate a servicer’s actual contribution to portfolio economics. The $2T private lending market — which grew 25.3% in top-100 volume in 2024 — is not short on capital. It is short on operators who understand its true cost.
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Professional loan servicing is the infrastructure that makes these metrics measurable. Without clean payment records, accurate escrow tracking, and documented default timelines, the terms in this glossary remain theoretical. With them, they become the basis for decisions that compound over time into meaningful competitive advantage.
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Frequently Asked Questions
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What is the difference between cost of capital and interest rate on a private mortgage note?
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The interest rate is what the borrower pays. The cost of capital is what it costs the lender to fund the loan — equity returns expected by investors plus interest paid on any borrowed funds. The spread between the two is the lender’s gross margin before servicing costs, origination expense, and default reserves are deducted.
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How much does it cost to service a private mortgage loan per year?
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The MBA’s 2024 Servicing Operations Study puts performing loan servicing cost at $176 per loan per year and non-performing loan servicing cost at $1,573 per loan per year. The 9x difference makes default prevention a capital cost management strategy, not just a relationship issue.
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What happens to my WACC when I raise more debt capital to fund new loans?
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Adding debt capital changes the weight of each component in your WACC calculation. If debt is cheaper than equity — which it is in most structures — adding debt initially lowers WACC. But as the debt-to-equity ratio rises, lenders charge higher rates to compensate for increased default risk, and WACC rises again. The optimal capital structure minimizes WACC at an acceptable risk level.
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What does foreclosure actually cost a private lender?
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Direct foreclosure costs range from $50,000–$80,000 in judicial states to under $30,000 in non-judicial states, per industry data. The national average foreclosure timeline is 762 days (ATTOM Q4 2024), meaning capital is locked for over two years in addition to direct legal and property preservation costs. Opportunity cost during that period adds significantly to the total.
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How does professional loan servicing reduce my effective cost of capital?
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Professional servicing reduces cost of capital through three mechanisms: it keeps performing loans performing (avoiding the 9x cost jump to non-performing servicing), it accelerates payoff processing to speed capital recycling, and it produces clean documentation that reduces the liquidity premium buyers demand when you sell notes. Each effect compounds across a portfolio over time.
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Do I need to calculate WACC if I only use my own money to fund private loans?
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Yes. Equity capital has a cost — it is the return you expect for the risk of deploying your money into private mortgages rather than any alternative investment. A single-source equity lender’s WACC equals their required equity return. Ignoring it means accepting returns below your own threshold without recognizing it.
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What is a loan loss reserve and how much should I hold?
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A loan loss reserve is capital set aside to absorb expected default losses. The right amount depends on your portfolio’s LTV distribution, borrower credit profile, geographic concentration, and historical default rate. There is no universal percentage — reserve adequacy requires portfolio-specific analysis. Regulatory guidelines and institutional investor due diligence both examine reserve methodology. Consult a qualified attorney and financial advisor to establish reserve policy for your specific operation.
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This content is for informational purposes only and does not constitute legal, financial, or regulatory advice. Lending and servicing regulations vary by state. Consult a qualified attorney before structuring any loan.
