Investing in real estate can be a lucrative way to make money, but it generally requires a substantial amount of money. It’s why most investors will take out a loan to help cover the costs of an investment property. Even successful investors borrow money instead of paying for new property out of pocket.
However, if you do plan to dive into the world of real estate investing, you’re going to have to rely on a good credit score if you plan on taking out any type of investment loan.
Why Are Credit Scores Important?
Your credit score is one of the first things a lender will look at when you apply for an investment property loan. A low credit score means you’re a high-risk borrower, and that you’re more likely to miss payments or default on your loan.
As a result, you’ll be less likely to qualify for an investment property loan – especially since lenders are stricter about investment loans than they are for conventional mortgages. The reason for this is simple: borrowers are less personally invested in their investment properties than they are in their own homes.
After all, if you default on an investment loan, you won’t lose your home. But if you default on your home mortgage, you could potentially lose your home to foreclosure. Because of this, lenders are more wary about investment property loans than they are about personal home mortgages.
Even if you do meet the threshold for qualification, a lower credit score can result in less favorable terms, such as a higher interest rate. As such, it’s worth the time and effort to boost your credit score before you apply for an investment property loan.
How Does Your Credit Score Work?
Your credit score is a number that ranges from 300 to 850, and it’s based on the information in your credit report. This number is used by lenders as an indicator of how likely you are to repay your debts.
Your credit score is important because it can affect your ability to get a loan and determine the terms of that loan. A higher credit score means you’re more likely to repay your debts, so lenders are more likely to offer you a loan.
Conversely, a lower credit score means you’re more likely to default on your loans, and therefore lenders will be hesitant to lend money to you.
Your credit score is calculated based on a number of factors. The following are some of the factors that contribute to your credit score calculation:
Payment History
Your payment history is an essential factor when it comes to your credit score calculation. It accounts for 35% of your score. Lenders want to see that you’ve made your payments on time and in full.
If you have a history of late or missed payments, it could affect your score. A poor payment history indicates to lenders that you’re either financially irresponsible or you don’t have the means to pay your bills on time (which means you probably can’t afford to take on any additional debt).
On the other hand, if you have a long history of paying on time and in full, it could help your score.
Amount Owed
Your “amount owed” is another important factor in your credit score calculation, and accounts for 30% of your score. This refers to the amount of debt you have in relation to your credit limit.
For example, if you have a credit card with a $1,000 limit and you owe $500 on that card, your debt-to-limit ratio is 50%. The lower your debt-to-limit ratio, the better. A high debt-to-limit ratio indicates to lenders that you’re using a large portion of your available credit, which makes you a higher-risk borrower.
Even if you have an excellent payment history, lenders will consider it a red flag if you owe a substantial amount of money. From a lender’s perspective, the fewer debt obligations you have, the more likely you’ll prioritize paying back the investment loan.
Lines Of Credit
Your “lines of credit” is an important factor in your credit score, and it accounts for 15% of your score. This refers to the number of credit accounts you have open. It’s good to have multiple lines of credit open as long as your payment history is good and you don’t owe a significant amount of money.
Having multiple lines of credit (especially older lines of credit) indicates that you are financially responsible and can manage the loan you’re applying for. On the other hand, having too many lines of credit open can be a red flag, especially if you’re having trouble with your payments and the amount you owe is steadily increasing over time.
Types Of Credit
Your “types of credit” accounts for 10% of your credit score. This refers to the different types of credit you have (e.g., mortgage, car loan, and credit card).
It’s good to have a mix of different types of credit because it shows that you can responsibly manage different types of debt. However, if you only have credit card debt and no other debt, it might show to lenders that you don’t have much experience managing debt (like a mortgage or car loan).
New Credit
Your “new credit” also accounts for 10% of your score. This refers to the number of new credit accounts you’ve opened recently.
Opening multiple new credit accounts in a short period of time can be a red flag because it can indicate that you might be struggling financially. This is because lenders will assume you’re having difficulty paying for things in cash and are therefore applying for multiple lines of credit to help pay your bills.
Not only does this usually translate to more debt, it also means that you’ll have other financial obligations to take care of. Lenders want to make sure you can prioritize paying back their loan. If you have other lines of credit you’re paying down, it could make it difficult for you to meet the payment dates for your investment loan.
It’s also worth noting that when you open a new credit account, it lowers the average age of your credit history, which can have a negative impact on your credit score.
What Is Considered A Good Credit Score?
Although there are different types of credit scores, FICO (Fair Isaac Corporation) is the most common. FICO credit scores range from 300 to 850. The higher your score, the better. The following are the five FICO credit score tiers (although it’s worth noting that the tiers can vary slightly from one source to another):
- Excellent Credit: 800 or higher
- Very Good: 740-799
- Good Credit: 670-739
- Fair Credit: 580-669
- Poor Credit: 579 and below
Minimum Credit Score By Loan Type
The minimum credit score you need to qualify for a loan will depend on the type of loan you’re applying for. For example, you’ll need a credit score of at least 620 to secure a conventional mortgage loan.
However, when it comes to investment property loans, lenders could require a higher minimum credit score because investment loans are considered higher risk than home mortgage loans.
The following is a more detailed breakdown of the different types of real estate loans that are available, and the minimum credit score requirements of each loan:
Conforming Mortgages – 640
A conforming mortgage is a loan that meets the guidelines set by government-sponsored enterprises Fannie Mae and Freddie Mac. A conforming loan is limited to a set amount for a single-family home in most U.S. states (higher limits are available in high-cost areas) – although this amount does increase on a year-by-year basis.
If you qualify for a conforming mortgage, you’ll likely get a lower interest rate than you would with an investment loan because they carry less risk for lenders.
The minimum credit score for a conforming mortgage is 640, but you’ll likely need a higher credit score to qualify for the best interest rates.
Conventional Loans – 620-760
A conventional loan is a non-government loan that is not backed by the federal government. There are two kinds of conventional loans that you can apply for: conforming and non-conforming.
A conforming loan meets the guidelines set by government-sponsored enterprises Fannie Mae and Freddie Mac, while a non-conforming loan does not.
The minimum credit score required to qualify for a conventional loan depends on the lender. Some lenders may require a minimum credit score of 620, while others may require a higher score of 760 because they are less willing to take on risk.
Jumbo Loans – 700 – 740
A jumbo loan is a non-conforming loan that exceeds the Fannie Mae and Freddie Mac guidelines for loan size. Jumbo loans are typically used to finance luxury homes or properties in high-cost areas.
The minimum credit score for a jumbo loan is typically 700, but some lenders may require a higher credit score of 740.
FHA Loans – 500-680
A Federal Housing Administration (FHA) loan is a type of mortgage loan that is insured by the FHA. The FHA insures loans that are made by private lenders, and the FHA guarantees that the loans will be repaid even if the borrower defaults on the loan.
As a result, there’s much less risk for the lender, which is why they’re willing to offer FHA loans to borrowers with credit scores as low as 500.
VA Loans – 640-721
A Veterans Affairs (VA) loan is a type of mortgage loan that is guaranteed by the VA. The VA guarantees that the loan will be repaid even if the borrower defaults on the loan. VA loans are only available to veterans, active-duty service members, and reservists.
The minimum credit score for a VA loan is 640, but some lenders may require a credit score as high as 721. A higher score is required for this loan type compared to other federally-backed loans because VA loans come with incredibly beneficial terms, including zero down payment and no monthly mortgage insurance.
USDA Loans – 640
A United States Department of Agriculture (USDA) loan is a type of mortgage loan that is guaranteed by the USDA. The USDA guarantees that the loan will be repaid even if the borrower defaults on the loan.
The USDA loan program is designed to help borrowers who are interested in buying a home in a rural area, which means only borrowers looking to purchase property in designated areas can qualify. The minimum credit score you’ll need to qualify for a USDA loan is 640.
Asset-Based Lenders – 640
Asset-based lenders are private lenders that use the borrower’s assets as collateral for the loan. Asset-based loans can be used for a variety of purposes, including business loans, investment loans, and more.
The minimum credit score for an asset-based loan is typically 640, but some lenders may require a higher credit score. There’s generally less risk involved in an asset-based loan for lenders because they can seize the borrower’s assets if the borrower defaults on the loan.
What Factors Affect Your Credit Score?
Understanding the factors that affect your credit score can help you improve your credit score (and help prevent your score from going down). Here are some of the most important factors that affect your credit score:
Credit Usage
Credit usage is the amount of your credit limit that you are using at any given time. The lower your credit usage, the better it is for your score.
If you are using a lot of your credit limit, it can signal to lenders that you are overextended and may have difficulty making your payments.
Length Of Credit History
As previously mentioned, the length of your credit history affects your score. A long credit history shows lenders that you are a responsible borrower who has a history of making on-time payments.
If you have a short credit history, it can be difficult to get a high credit score because there is not much data to go on. Lenders may be hesitant to give you a loan if you have not demonstrated a long history of on-time payments. They may assume that you don’t have a lot of experience handling debt. As such, they can’t be sure if you’ll be able to handle the responsibility of taking out a loan.
Types Of Accounts
Again, the types of accounts you have will also affect your credit score. If you have a mix of different types of accounts, it shows lenders that you’re a responsible borrower who can handle different types of debt.
For example, having both a revolving account (like a credit card) and an installment account (like a car loan) can give lenders a better idea of your borrowing habits as well as your level of financial responsibility.
Recent Activity
Your recent activity is also a factor that lenders look at when considering your credit score. If you’ve been opening a lot of new accounts or if you’ve been using a lot of your credit limit, it can signal to lenders that you’re in need of money and may have difficulty making your payments – or that you’re just not very financially responsible.
How Your Credit Score Affects Your Application For Real Estate
Real estate is expensive, which means the amount you need to borrow as an investor tends to be significant. Furthermore, large loans carry more risk, which is why lenders will pay careful attention to your credit score. The last thing a lender wants to do is approve a loan to someone who is unable to repay the loan.
Although the lender will be able to foreclose on the property in question, there’s no guarantee that they will be able to sell it and get their money back. Not to mention that they will have to spend time and resources on the foreclosure process, which can end up being expensive – especially if they have trouble selling the property.
As a result of the inherent risk of real estate investing, lenders tend to have more stringent credit score requirements when it comes to investment property loans. If you don’t have a good credit score, not only could it become difficult to qualify, but it will affect your potential profits since your interest rate will likely be high if you do qualify.
Can You Secure Real Estate Loans With A Poor Credit Score?
Sometimes, a lower credit score may not reflect your current financial situation. You may have had some financial difficulties in your past that were out of your control. Although you may be in good financial shape today, your credit score may not reflect that.
Fortunately, it is still possible to get a real estate loan with a poor credit score. However, it’s not always easy. Lenders will often require a higher interest rate to offset the risk of lending to someone with a lower credit score. And, in some cases, you may need to provide a larger down payment.
If you’re looking to invest in real estate but your credit score isn’t where you want it to be, there are a few alternative ways to obtain a loan, such as:
Hard Money Loans
A hard money loan is a short-term loan that is backed by real estate. Essentially, you would use the property you’re investing in as collateral. Hard money loans do come with a higher interest rate and, because they are short-term, the monthly payments tend to be high as well.
However, hard money loans are an excellent option for investors who need money quickly, such as those investing in fix-and-flip properties. They are also easier to qualify for because they are secured by the property itself, which means a lower credit score won’t necessarily be a deal-breaker.
Private Money
A private money loan is a loan that is funded by an individual or a group of individuals. Private money loans are often used by real estate investors who are looking to invest in fix-and-flip properties.
Like hard money loans, they are easier to qualify for because they are secured by the property you’re investing in. As a result, you don’t generally need a high credit score to qualify. But, private money loans often come with higher interest rates and shorter loan terms.
Partnerships
Forming a partnership allows you to pool your resources and increase your buying power. Not to mention, it can help offset the risk for the lender since they’ll be lending to two people instead of just one.
Of course, this does mean giving up a certain degree of control and profit potential. But, if your goal is to simply get started in real estate investing, it may be worth considering.
Cosigners
If you’re having trouble qualifying for a real estate loan on your own, another alternative you may want to consider is finding a cosigner. A cosigner is someone who agrees to sign the loan with you and is legally responsible for repaying the debt if you can’t.
Using a cosigner can be a good option if you have a family member or friend who is willing to help you out. Just keep in mind that cosigning a loan is a big responsibility and it could negatively impact your cosigner’s credit score if you’re unable to make your payments.
How To Boost Your Credit Score
If your credit score is holding you back from getting the financing you need to invest in real estate, there are a few things you can do to try and boost your score.
Some of the things you can do to improve your credit score include:
- Make any payments on time: Focus on making all of your payments on time. This includes everything from your utility bills to your credit card bills.
- Keep your credit utilization low: Your credit utilization ratio is the amount of debt you have compared to the amount of credit you have. Try to keep your credit utilization lower than 30%.
- Review your credit reports: You’re entitled to one free credit report from each of the three major credit bureaus every year. Review your reports to check for errors or inaccuracies, and dispute them if you find any.
- Keep your credit cards open: It may seem counterintuitive, but closing unused credit cards can negatively affect your credit score. Closing a line of credit can lower your credit utilization ratio. So, even if you don’t plan on using a particular credit card, it’s generally best to keep it open.
- Obtain diverse credit lines: Consider obtaining a diverse mix of credit lines. For example, if your credit lines are limited to credit cards, you could take out a small personal loan to pay off your credit cards. Not only can you save on high credit card interest this way, but you’ll diversify your credit lines as well.
- Work with a credit counselor or lender: If you’re having trouble improving your credit score on your own, you may want to consider consulting a credit counseling service or speaking to a lender about your options.A credit counselor can help you develop a plan to improve your credit score. And, a lender may be able to work with you to help you qualify for a loan, despite your low credit score.
A Good Credit Score Will Make It Easier To Secure Real Estate Loans
One of the most important things to remember when trying to secure real estate financing is that your credit score matters. The higher your credit score, the easier it will be to qualify for loans. And the better your chances of getting approved for a loan with favorable terms. As such, if your credit score is holding you back from investing in real estate, take the time to improve it.