Real estate investing is an excellent way to gain equity and financial security. However, paying cash for property is not always the best option. It may be if you see a home you need and you don’t have time to get approved for a mortgage, but otherwise it is best to diversify your investments and put your money to work somewhere it will earn more interest than what is accruing on your mortgage. Besides, not all of us have the cash lying around to purchase a home outright and even if we did, we may not have enough in savings for property taxes, insurance or emergency repairs. Today, we will discuss a crucial part of gaining access to capital for your new business–your credit score.
Real Estate Investing: What Is A Good Credit Score?
First, let’s talk about what a credit score is and why a good one is crucial to your real estate investing strategy. A credit score is a valuation of your risk as a borrower. This affects not only your interest rate but your ability to get a loan. If lenders think you are a high-risk borrower, they will either charge you exorbitant interest rates or not lend to you at all. This is no good if you are looking to start a real estate investing business.
Different lenders will pull credit reports from different bureaus who use different models of determining your score. Mortgage lenders typically use older FICO models. Do your homework and find out which scoring model your potential lender will use. The FICO 8 model uses the following weighted system to get your credit score:
- Payment history–35%
- Payment history is the most important factor in determining your credit score, no matter which model is being used. Even if you can’t pay your balance in full, make at least the minimum payment on time every time. Timely payments will increase your score while late or non-payments will decrease your score. Bankruptcy and debt charged off to collections can affect your credit score for seven to 10 years.
- Outstanding balances–30%
- We will discuss outstanding balances in greater detail later on. The Cliff Notes version keeps your utilization roughly between 0 and 9%.
- Length of credit history–15%
- Types of accounts–10%
- It is important to show you are responsible with revolving credit. However, when applying for a mortgage, it is also important to show you can make good faith payments regularly. It’s easier to not run up your credit card because you can’t afford to pay it off for the month than it is to make your car note every month. Your mortgage will come due every month regardless of anything else.
- Credit inquiries–10%
- Excessive credit inquiries show you may not be in a financially stable place. You can apply for nine auto loans through different companies in 30 days, and that will only count as one inquiry because you are shopping around for the best rate. It looks bad when you are looking for a mortgage, auto loan, installment loan, cash line of credit and payday loan at the same time.
How To Improve Your Credit Score
Now you know what a good credit score for real estate investing is and why it is important. So how do you improve it? Today, we will discuss five simple, actionable steps to improve your credit score. While you can take these steps today, results will not happen overnight. However, neither will success at building a real estate investing business, but that isn’t stopping you. Let’s dive in.
Know Your Current and Goal Scores
The only way to get where you want to go is to know where that is and where you are. Have you ever seen a map at the mall that didn’t tell you where you were? This may be self-explanatory, but it really is crucial. Once you know your credit score and where you want it to be, you can use online calculators that will show you the effects of which steps you take next. This will give you a roadmap and journeys are always much easier with achievable checkpoints.
Variety of Scores
As previously mentioned, 30% of your credit score is based on having various types of open credit. You shouldn’t go out and finance a car so you have an open installment loan on your credit report. However, some serious real estate investors take out a small, long-term installment loan. The interest they pay is dwarfed by the interest they save when they finance their next property purchases with excellent credit scores.
It is a myth that FICO rounds your credit utilization up to 10, 30, 50 and 90% when factoring utilization into your score. In fact, they use 8.99, 28.99, 48.99 and 88.99 as benchmarks. Note, they round up, so you really want your open balances to be 8.98 or less. FICO does not look at only your overall credit utilization. You will be penalized if you have an average open balance of 7%, but one of your cards has a 32% utilization rate.
No Debt is Not Always Better
While it is important to keep your credit utilization below 8.99%, it does not necessarily behoove you to have no open balances on your credit cards. Ideally, have an open balance on at least one credit card but no more than 1/3 of your credit cards. This is because you are not just penalized for not having revolving credit, you are penalized for not using the revolving credit you have available. Don’t worry. Credit utilization has no memory, so all you need to do is buy a tank of fuel on your credit card and not pay it off until after your credit has been run.
Three to Five Open Lines of Credit
An important factor in proving you can manage debt is having several open lines of credit. You will find a boost in your score at three credit cards, then again at five lines of credit that have been open for at least two years.
Your credit score is a major piece of the puzzle when seeking a loan for your real estate investing business. It affects how quickly you get approved and the interest rate of your loan. But it is not a mysterious thing you have no control over. While the public does not know the exact formula for calculating credit scores, there are simple, actionable steps you can easily take this week to improve your credit score.
It will not happen overnight, but if you are patient, it will be well worth it. Keep an open balance on 1/3 of your cards of 8.98% or less, have between three and five lines of credit, have both open installment and revolving credit debt, understand which model your lender will use to determine your credit score and never forget where you want to go.