The Importance of Your Credit Score in Real Estate
Before getting started, investors typically have one question in mind: How important is my credit score in real estate?
The importance of a good credit score should never be undervalued, especially for real estate investors. Great credit equates to better deals and money-saving tactics, which, in return, provides multiple options to finance real estate and navigate the mortgage lending process. The secret is understanding how a credit score is calculated and what factors affect it.
A typical credit score is analyzed in points. FICO, the most popular scoring model, ranges from 300 – 850:
Bad credit: 300 – 600
Poor credit: 600 – 649
Fair credit: 650 – 699
Good credit: 700 – 749
Excellent credit: 750 – 850
It’s also important to note there are several credit scoring models—Equifax, Transfix and VantageScore—that each have their own evaluation systems, which are based on different factors. Generally speaking, however, a typical credit score calculation is comprised of five major factors:
Payment history = 35%
Outstanding balances = 30%
Length of credit history = 15%
Types of accounts = 10%
Credit inquiries = 10%
Credit scores are important in the eyes of a lender because it determines what risk you pose to them. It essentially provides a statistical method to determine the likelihood a person pays back the money they have borrowed. The average credit score for a conventional real estate loan is 752. Scores above 760 are viewed as top tier, with lenders generally offering the best rates and most choices for these borrowers. Credit scores below 620 fall into the subprime category, which can make it much more difficult to locate a loan provider.
Credit scores are built over long periods of time with several key elements influencing them. As a real estate investor, the first step is to pull your credit report and evaluate where you stand. There are three major U.S. credit bureaus—Experian, Equifax and TransUnion—and each one uses its own method to determine a score. For those with less-than-favorable scores, it’s important to realize that those scores can always be improved. The next step is understanding how to move forward with bad credit.
Can someone with bad credit invest in real estate?
For investors with good, bad or ugly credit scores, there's always alternative ways to obtain financing. While some may or may not apply to you, the most important aspect is understanding the options made available. Here are some of the common—and not so common—routes for investing in real estate with bad credit:
Hard money: As a real estate investor with bad credit, hard money lenders are your ticket to success, as your credit score is not a make-or-break consideration. Unlike traditional financing methods, these lenders typically consist of individuals or businesses that provide money with high interest rates and short terms to real estate investors. In most cases, hard money interest rates range between 10% and 18%, with lenders charging additional fees known as “points,” which can add up to anywhere from 3% to 10% of the loan amount.
Hard money loans typically are determined by what’s known as the loan-to-value (LTV) ratio, which is calculated by dividing the ratio of loan amount with the value of the property. In most cases, hard money lenders will lend upwards of 65% to 75% of the current value of the property.
The good news for real estate investors with bad credit is that hard money lenders are paying attention to the value of the deal, rather than solely on an investor’s credit score. Their primary concern is the property’s value and the security of the deal.
Private money: Another form of financing is private money. Similar to hard money, private money lenders are secured from private groups or individuals that set their own criteria, including dictating the terms, fees, rates and guidelines. For some, credit scores may play a factor, but these lenders are generally looking to diversify their money into other investments, including a healthy return on investment. The most important aspects of a private money loan are:
Asset-based lending: For beginners with bad credit, private money lenders are a terrific resource to have because they are driven by the value of the investment property rather than credit scores.
Speed of purchase: For investors short on time, private money lenders can fund a loan in as little as seven to 21 days, while banks typically take upwards of 90 days or more to complete.
Wholesaling: Another creative way to invest in real estate with bad credit is achieved through wholesaling. This innovative strategy consists of finding properties that can be acquired at significantly lower market value prices, controlling them through the use of a special agreement, and then finding a buyer willing to purchase your contract. In most cases, no money down is needed and no credit check is ever performed, making it one of the more innovative ways to invest in real estate with low credit scores.
FHA loans: One of the more popular ways to invest in real estate with bad credit is through an FHA loan. This option, which is mandated by the Federal Housing Administration, a division of the Department of Housing and Urban Development (HUD), requires a credit score of 620 and a minimal down payment of 3.5%. Although FHA doesn’t actually make home loans, it does guarantee the lender will be repaid if you default on the loan.
While you can still get an FHA loan with below-average credit, there are some guidelines. For one, applicants must have a two-year history of steady employment, including paying their bills on time. For self-employed investors, you’ll need to provide documents of your income with tax returns and financial statements from your business. Other qualifications include: a minimum credit score of 600; a non-delinquent standing on a federal debt, such as student loans or income taxes; two years removed from Chapter 7 bankruptcy and three years removed from a foreclosure.
The credit structure of FHA loans could potentially change in the upcoming future. According to a relatively recent report, the National Association of Realtors and HUD are working together to reassess the entire credit structure, as well as locate ways to increase the availability of credit to qualified borrowers who are good credit risks.