One of the best assets a real estate investor can have is a good credit score. There is a direct relationship between credit score and interest rates. But if yours is less than perfect, you can still invest in real estate — you’ll just fine the process to be more difficult and time-consuming.
What is a credit score?
Credit reports are kept by the three major credit agencies: Experian, Equifax and TransUnion. A credit score is calculated with a formula created by Fair Isaac, a software company more commonly known as FICO. You have three different credit scores, one for each of your credit reports. The credit score is based on the information in your credit report. For example, the reports show whether you are on time or late with payments. They also note whether you have had any serious credit problems in the past.
Know your credit score
Before moving forward with any real estate investment, it is important to know where your score stands. It is possible to get a free credit report from each of the three major credit bureaus simply by going to AnnualCreditReport.com.
If you have not checked your credit score in a number of months, it is vital to check it before moving forward with an investment. Many people wrongly believe their credit score is impacted only by big-ticket purchases such as a car or major appliance. In fact, credit scores change every month. Your credit score is based on:
- The timeliness of payments
- Amounts owed
- How long each account has been open
- The number of new accounts recently opened
How your score affects your investments
Good credit can get you better rates. Most investment programs require a score of at least 700. Others will require a score as high as 720. Without such a score, you will have great difficulty finding a lender to finance a loan. To lenders, a low credit score equates to a higher chance of delinquency. Ultimately this means a higher risk premium on your loan or a denial of your application.
However, your credit score isn’t just viewed by lenders. Insurance companies, building suppliers and utility companies may also take a look.
Insurance companies investigate credit scores before determining whether to provide insurance coverage and at what cost. While there may be no correlation, the companies believe low credit scores increase the probability that an insurance claim will be filed.
Utilities and companies that provide building supplies use a credit score to evaluate whether to extend credit and, if so, how much. They typically hold back credit to applicants with low credit scores and require cash payments, or at least significant deposits, for products and services.
Check regularly for errors in your report
Reviewing your credit report from time to time will help you keep on top of any errors that may pop up. Because no process is perfect, mistakes do happen. The federal Fair Credit Reporting Act (FCRA) promotes the accuracy and privacy of information in the files of the nation’s credit reporting companies. Under the FCRA, both the credit reporting company and the company providing information about you are responsible for correcting inaccurate or incomplete information in your report.
If you find an error, it is important to report it. The Federal Trade Commission provides information on steps to take as well as sample dispute letters.
Is it possible to invest with low credit score?
As noted previously, a low credit score doesn’t prevent you from investing in real estate; it does, however, make the process more difficult.
If you have a credit score below 720, you are not alone. According to FICO the average score is 695.When you look at the full range of Americans’ scores, 54.7 percent fall into the “Good” or “Excellent” categories. Another 23.3 percent have Fair scores (roughly 600 to 699), and 21.9 have scores below 600, which is considered Bad.
Your credit score is a number that represents your financial ability to manage your money. Because having a low credit score signals to lenders that you are more likely to default on your loan, the lender must charge a higher rate of interest to make it worth the risk. That will mean higher mortgage payments, plus you may be required to carry mortgage insurance.
If you’re facing higher than average interest rates, you may want to stop and weigh all the factors. Even though it is possible to make the investment, should you? Because so many lenders look at those credit scores as an overall reflection of one’s ability to handle money, consider your own score and ask yourself whether it is a symptom of a bigger problem.
Investing in real estate will not fix bad money habits. However, if you can reflect on what has caused your low score and know you are in the process of resolving the issue, investing may be a good step. As you make payments and your score improves, you represent less risk to the lender. You are then often rewarded with a lower interest rate.