Your credit score is one of the most important factors for getting into real estate investing.
A bad credit score means no loans. And no loans? Not real estate for you... (at least with traditional bank financing in your own name, but more on this later).
So it is absolutely imperative that new investors and anyone trying to get into the game first learns the credit game. How the credit system works, what factors contribute to your score, and how to quickly improve your score. All things I will cover right now.
How the Credit System Works
Your credit score is really a number given to you by the Fair Isaac Corporation (commonly referred to as FICO). Using a number of different ways to calculate this number, you can get different credit scores. For example, my current FICO 7 could be 758, while my FICO 8 is 772. Subtle differences in the weights of different factors can be helpful for lenders offering different types of credit or loans.
Regardless of which specific credit scoring system you need for a given loan all scores are based on the same principles.
How many missed or late payments you have made.
Aim for 100% of payments made on time. 99% is not bad, and 98% is considered fair. But if your payment history dips below 97% you will see a massive dip in your credit score.
Based on how much available credit you have, how much do you use?
Credit Utilization is your percentage of credit card debt relative to your total available credit limit.
Creditors want to know that you manage your credit responsibly and won't max out your lines and run off with their money. Because of this, your credit score rewards you for utilizing a very small percentage of your available credit.
For example, let's say you have $20,000 of available credit spread out across a few credit cards. If you have a $4,000 balance, your credit utilization rate would be 20%. The highest credit scores keep this number under 10% and the lower the better.
How long you've been in the credit game. People who have been managing their credit longer are more trustworthy to creditors. They will look at various metrics such as the average age of all of your accounts, and the age of your most recently opened account.
This is one of the most challenging credit factors in my opinion because the only way to see improvement in the area is to wait for your accounts to age. You could close out your younger accounts to bring up the average, but that might not necessarily help you given the next factor, total accounts.
How many open credit accounts do you have?
Add up loans, mortgages, credit cards, and see where you stand. The highest credit scores have more than 21 open accounts.
From a creditor's perspective, having more accounts combined with a low utilization rate, on-time payments, and aged accounts, all point to you knowing how to manage your credit responsibly. The more accounts you have the harder it can be and the more the credit system rewards you.
It's best to avoid getting any derogatory marks on your credit report. They stick around for 7-10 years can have a big impact on your score.
Do everything you can to avoid being sent to collections. Having a history of debt collectors chasing owed debts is the biggest red flag to creditors. If you aren't paying off your existing debts, they are less likely to give you money or credit that you might not pay off.
Additionally, public records like bankruptcies, tax liens, and civil judgements will all be red flags to creditors and can tank your credit score.
You need to understand the difference between hard inquiries and soft inquiries.
The most important factor is that hard inquiries show up on your credit report and soft inquiries do not. Hard inquiries are common when you apply for credit, loans, and mortgages. This is important to distinguish because creditors care about how frequently you are trying to obtain new lines of credit.
If you are getting too many inquiries, creditors might look at this as if you need the money and are facing financial hardship. These borrowers are less likely to repay debts on time relative to those who aren't facing financial hardship.
So the goal is to keep inquiries low.
Luckily, they go away after 2 years and typically hold less importance overtime during those first 2 years. The best credit scores have 0 hard inquires, while good scores may have 1 or 2. Any more than that and this factor alone could disqualify you for new credit cards and loans.
That is an overview of how the credit system works, factors that will affect your score and how the credit bureaus measure each factor. If you find your score isn't where you want it to be, get a copy of your credit report and see where you stand with each factor. Odds are there is at least one you can improve, and if not most of them will simply improve with time and responsible credit use anyway!
Still have questions? You can reach me on Twitter at @investordill and fire away!