The Role of Credit Scores in Investment Financing

February 13th, 2024

Introduction

Purchasing investment properties can be an exciting yet challenging endeavor. As real estate investors ourselves at Empire 8 Property, we understand the critical role that credit scores play in determining financing options and rates. We aim to provide an in-depth look at what credit scores are, why they matter so much to lenders, and how investors can work to improve their scores. Reading through this guide will give you the knowledge needed to put your best financial foot forward on your real estate journey.

What is a Credit Score?

Before diving into why credit scores influence real estate investing, let’s start with the basics – what even is a credit score? Your credit score is a three-digit number ranging from 300 to 850 that indicates your “creditworthiness” or likelihood to repay debts. The higher the number, the lower lending risk you pose in the eyes of banks and other financial institutions.

Credit scores are calculated based on information in your credit reports from the three major reporting bureaus – Experian, Equifax, and Transunion. They take into account five main factors:

  • Payment history – Whether you pay your bills on time, including mortgages, credit cards, utilities, etc. This holds the greatest weight.
  • Total debt burden – How much you currently owe across all accounts relative to your overall credit limits.
  • Credit history length – How long you’ve had access to credit, including oldest account age.
  • New credit inquiries – Number of recent requests for new credit, which can indicate increased risk.
  • Credit mix – Variety of account types, including credit cards, retail accounts, car loans, student loans, and mortgages.

Each of the three credit bureaus may use slightly different models to produce your score, but they generally fall into defined ranges:

800-850 Excellent
740-799 Very Good
670-739 Good
580-669 Fair
300-579 Very Poor

 

Importance for Real Estate Investment Financing

As real estate investors, credit scores greatly influence the financing offers we qualify for when looking to purchase rental properties or other investments. The main reasons they matter so much to lenders include:

Indication of Repayment Capacity

Credit scores provide banks and other financing institutions with a snapshot of how reliably an applicant has repaid debts in the past. Higher scores signal lower lending risks in their view. Many lenders have set minimum score requirements as a result (620+ being common).

Determining Interest Rates

In addition to dictating what programs investors qualify for, credit scores also directly influence the loan terms. The higher your credit score, the lower interest rate you can generally obtain on rental property mortgages, refinances, and lines of credit. Even small differences can save tens of thousands over the life of the loan.

Loan Program Qualification

Each rental loan program – whether for a duplex, 4-unit, or larger apartment complex – typically requires meeting credit score thresholds. Conforming loans start at 620, while loan programs that account for lower scores often have higher rates/fees. Improving your score can open up better financing options.

Impacts on Insurance Rates

Beyond loan terms themselves, poor credit scores can even lead to higher rental property insurance rates in certain cases. Some providers may view lower scores as indicative of a higher risk tenant pool. Maintaining excellent credit can prevent these extra costs.

Boosting Your Credit Scores

If your current credit score falls short of where you’d like it to be as a real estate investor, take heart. Scores can frequently be improved substantially within 6-12 months by following responsible credit management practices:

  • Pay all bills on time – Set up automatic payments whenever possible. Checking due dates and paying promptly prevents late payments being reported.
  • Pay down balances – Reduce credit utilization by paying down cards and other revolving debt. Experts recommend keeping usage below 30%.
  • Limit new inquiries – Apply conservatively for new credit only when needed to avoid too many hard inquiries. Shop mortgage rates within a focused window.
  • Build a healthy credit mix – If new to credit, consider securing an installment loan (car, personal) or secured card to establish a positive history.

Sticking to these credit best practices takes discipline but serves as a foundation for financing approvals. We also recommend checking credit reports from AnnualCreditReport.com to identify and dispute any errors.

Financing Options for Lower Credit Scores

For real estate investors with credit scores below typical conforming loan levels, all hope for financing is not lost. While improving scores long-term is ideal, the following options could bridge the gap:

Hard Money Loans

Hard money loans are short-term financing options leveraging the property itself as collateral rather than credit scores or employment history. While interest rates generally start at 10% or higher, they can be used to rehab and flip homes quickly.

Private Lenders

Local private lenders may offer portfolio loans for those who don’t qualify for conventional mortgages. This comes at the cost of higher rates and short repayment periods, but can be an intermediate step.

Crowdfunding

Real estate crowdfunding platforms are growing in popularity as well. Turning to the “crowd” by pooling funds from multiple backers provides expanded access to capital based more on the deal specifics itself.

Partner Financing

Finding a joint venture partner with stronger credit scores is another avenue for those looking to break into rental property investments without meeting stringent criteria outright on their own. There areienced investors willing to mentor newcomers.

Seller Financing

Seller financing offers another route to investment property ownership without undergoing typical income/credit confirmation. If negotiating a purchase directly with the seller, some may be willing to act as the bank and hold a mortgage personally when buyers fall a bit short on qualifying. There are always creative win-wins to uncover in real estate!

The Bottom Line for Investors

At Empire 8 Property, our team has personally leveraged rental property financing options ranging from multi-family loans to private money bridges loans early on. We cannot overstate the value having strong credit provides throughout the investment process – from saving on interest expenses to negotiating better deals for financing. While building your portfolio, keep the key points below in mind:

Benefit of Good Credit Score

A higher credit score unlocks preferred rental rates and loan programs. Excellent credit saves tens of thousands over property lifetimes.

Impact on Loan Qualification/Process

Good credit means an easier loan process without extra documentation or restrictions. Taking time to boost your score makes real estate investing smoother.

Prioritizing Your Credit Score Matters

As emerging real estate investors, view credit score improvement as part of your journey. Establish responsible habits now that set you up for long-term financing success on bigger multi-family properties.

We hope this guide has provided greater insight into why credit scores influence so many aspects of real estate investment. Please reach out to our team at Empire 8 Property if you have any other questions!

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