How important is your credit score in real estate?
A quality credit score is one of the most valuable assets a real estate investor can have. This resource has the authority to not only retain attractive mortgage and refinancing rates, but amplify an investor’s negotiating power when seeking a loan. While a lower score will not automatically disqualify potential investors, this all-important number could hinder one’s ability to access certain loan programs.
“Credit scores are a crucial component of the homebuying process, impacting everything from the size of a mortgage payment to the interest rate on a home loan,” said Senior Vice President for TransUnion, Ken Chaplin.
“People with subprime credit may face financial barriers to homeownership, making it difficult for their dream home to become a reality,” said Chaplin.
The good news is that there are still ways to invest in real estate with bad credit, including several ways to do so without using a cent of your own money. As an investor, the first stage is to understand the importance of your credit score, including ways to improve it.
How Important Is Your Credit Score In Real Estate?
Before getting started, investors typically have one question loaded: how important is your credit score in real estate? The importance of a quality 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. The secret is understanding how a credit score is compiled 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 percent
- Outstanding Balances = 30 percent
- Length of Credit History = 15 percent
- Types of Accounts = 10 percent
- Credit Inquiries = 10 percent
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.
“The homebuying process begins well before you start looking for real estate,” Chaplin said. “A credit score, which significantly impacts the home financing process, is built on good spending habits and a pattern of responsible borrowing established over a lifetime.”
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 they 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 are always alternative ways to obtain financing. While some may–or may not–apply for 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 percent, with lenders charging additional fees known as “points” — which can add up to anywhere from three to 10 percent of the loan amount.
Hard money loans are typically 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 – 75 percent 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 consist 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 every 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 percent. 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: minimum credit score of 600; not delinquent on a federal debt such as student loans or income taxes; and 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 (NAR) 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.
“We’ll look at every option that brings housing opportunities within reach of more Americans,” said HUD Secretary Julian Castro.
While FHA loans typically cannot be used to finance an investment property, they have their place in the investor landscape; this includes refinancing an existing FHA loan or purchasing a duplex.
Subprime Loan: Another underrated option, which is starting to make a big comeback, is subprime mortgages. This alternative course of action offers different types of non-qualified mortgage programs, which are designed to assist those with below par credit scores. While a minimum credit score is required, many lenders have multiple programs in place for specific scores, making them very appealing for real estate investors with bad credit.
Having a quality credit score is a critical component for real estate investors because it’s a necessary ingredient to borrow money. Understanding the options available to you, including what’s required and how to obtain it, is the first step to investing in real estate with bad credit. How important is your credit score in real estate? It’s very important, but it’s not by any means a deal breaker.
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