As a real estate investor, I realize how important credit is to my career… do you? Poor credit scores often mean the difference between having to make a down payment of up to 35%, and a down payment of 10%. Or the difference between a 14% interest rate and a 6% interest rate. Or the difference between paying 4 points, and paying none. If those examples sound overstated, they’re not – hard money lenders (the only resort for many real estate investors with bad credit) routinely charge interest rates in the mid-teens, 4-6 points, and only lend at a 65% LTV (loan-to-value) ratio.
Don’t want this to be you? Here’s a brief overview of how credit scores are calculated, and how you can increase your scores.
Credit scores are determined by tabulating a wide range of financial information, including some basics that you’re probably already familiar with, and some less understood factors as well. One of the most commonly understood factors is payment history – how many on-time payments you’ve made, versus how many late payments. Not all monthly bills are reported to the credit bureaus; utility bills, services such as mobile phone bills, and the like are not (unless you rack up a large overdue balance, in which case they may send your account to a collection agency). Debt payments, on the other hand, almost always report – loans such as mortgages, auto loans, and credit card bills being prime examples. For this simple reason, these bills that are reported to the credit bureaus should take first priority, if you have to choose which bills to pay first.
Another well-understood factor in the calculation of credit scores is the appearance of negative public records, such as bankruptcies, foreclosures and judgments. Collection accounts are also a painful hit on your credit score, so resolve any unpaid balances before they’re sent to a collection agency.
There are some aspects of credit scoring that are less understood, such as the average age of your credit account. Credit bureaus prefer to see older (but still active) accounts, with a long-standing history of timely payments, and they will calculate the average age of all of your open accounts. It’s tempting to open a new credit card for every store you like to shop at, but don’t do it – stick with one or two credit cards, preferably ones you’ve already had for a long time.
Another less-understood factor that credit bureaus use to determine your score is the ratio of how much credit you use, versus how much you have available. They love to see people who have been granted high credit limits, but who don’t actually use them, and simply pay off their revolving debt each month. But it’s not about the amount of your credit limit, it’s about the percentage of your available credit limit that you use. It’s better to have a $1,000 credit limit, and only have a balance of $50, than to have a $50,000 credit limit and a balance of $47,000. Likewise, credit bureaus love to see car loans that you’ve paid down substantially, or mortgages you’ve had for ten years and continue to pay down on time, lowering the balance compared to the “credit limit” of the original balance.
We suggest obtaining a copy of your credit score every 4-5 months. Unfortunately, mistakes on credit reports are quite common due to misreporting or credit bureau errors. In order for you to become aware of such errors, you must regularly review your credit report. Correcting these mistakes is extremely important and a fast way to improve your score. That said, having your credit report pulled too often will have a negative effect on your credit score. Too much credit report activity paints the picture that you are desperately searching for credit wherever you can.
Improving your credit score should be a top priority. The number of real estate investments you can make, or even “how much house” you can buy, is directly impacted by your credit scores. If you have $20,000 saved to put down, and can afford $2,000/month on payments, that will go a lot further if your loan terms are 6% interest and a 10% down payment, instead of 10% interest and a 30% down payment.
