You just found a great real estate deal, rushed to lock down funding, and uh-oh. Your credit score is stopping you from getting the financing you want. What to do? Low credit scores, usually defined as below 550, can cost you thousands or even hundreds of thousands dollars of increased interest, penalties and fees over your borrowing lifetime. What's the best first step to boosting your score?
It’s not unusual for real estate investors' credit scores to fluctuate. Unexpected costs or soft sales cycles can affect your cash flow, bottom line and credit. However, when you try to get a loan or credit to fund that next great deal, you’ll quickly find that a weak credit score can disqualify you from the best financing rates. Fixing bad credit is a process; it’s important to first understand how your credit score works and then create an action plan to yield the quickest improvement.
Credit Score - What You Need to Know
Your credit score (often referred to as your FICO score) is based primarily on 5 factors:
- Payment history. Your on-time payment record is the most heavily weighted factor. And the later you pay, the more it counts against you.
- Credit utilization. Amount of debt you have relative to your credit limits. Below 25-30% is ideal.
- Length of credit history. Pretty simple and just like it sounds: how long you have had credit. To credit agencies, longer is better.
- Types of credit. Credit agencies look at your credit mix to see how you handle different types. Revolving credit (credit cards) counts more than installment debt (mortgages, car loans).
- Credit inquiries. How many “hard inquiries” (inquiries made by a prospective lender) have been made in the recent past. Fewer are better.
Action Steps You Can Take Now
- Get your credit score and report. The first step is to get your latest credit score and report so you can see the whole picture and figure out what to start improving first. Under the Fair Credit and Reporting Act, you can get a free credit report every year from each of the ratings bureaus. You can also check reviews.com to see who were rated as the top credit report services.
- Fix any errors in your credit report. Errors on credit reports are more common than you think. Frequent errors involve everything from incorrect identity information and outdated account status to incorrect balances and non-recorded payments. The credit report providers have dispute resolution procedures that allow you to correct any errors in the record, and, according to a recent Federal Trade Commission study, 79% of people who disputed an error on their credit reports had the error removed. That’s a quick ‘win' that will boost your score immediately.
- Pay your bills promptly. According to FICO, “more than 35% of your credit score is based on your payment history.” The later the payment, the greater the negative effect on your score. Overdue bills weigh heavily on the credit reports maintained by the Big Three credit bureaus -- Equifax, TransUnion and Experian -- as well as Dun & Bradstreet’s Paydex scoring system. Set up online payments wherever possible to avoid forgetting payment deadlines.
- Clear your outstanding balances. Focus on the account that charges you the most interest and pay it down first while making minimum payments to your other accounts. Reducing the debt you owe will improve your utilization rate and your credit score. Once the first account is paid off, turn your attention to the next highest rate. Continue until your credit utilization ratio (credit used/credit available) is below 25-30%.
- Negotiate with your creditors. Reach out to your creditors and work out a way to pay down your debts. Most creditors will work with you. The reality is that it’s easier and cheaper for them to work with you to collect what they can and set up a schedule for partial (often 30-50%) repayment. But you need to be proactive in setting this up with them, and ready with some good-faith cash to show them you are committed to making payments.
- Establish and build positive credit. You can build new credit to help your score. Secured credit cards are one option; these cards require a deposit usually in the amount of your credit limit, but paying them back in full every month helps build new positive credit. For business credit, work with your vendors to set up trade credit arrangements and then honor those arrangements by paying within the allotted time period. Some vendors report their trade information to the credit bureaus, and some don’t. If possible, seek out vendors who do report, because they can help boost your credit score if you consistently pay on time.
You can do it! Assess your situation, create your plan to boost your score, then dig in and get started! Just think of the thousands of dollars you will save long-term.
Walnut Street Finance provides creative financing for builders and developers in the Washington D.C. and surrounding markets. Our loans are based primarily on the equity in your project, and we do lend to investors with less than perfect credit. Read our blog about getting hard money financing with bad credit and see our website for usable tips and information about current real estate investment topics.