How is Your Credit Score Important in Real Estate? Can You Go for It with Low Credit?

There are many crucial steps to take before deciding to purchase a home. 

The mortgage application process is among the essential steps. Lenders examine your mortgage application and consider your income, work status, and down payment size. Lenders will also check your credit. 

Your chances may not be as good as you think. Additionally, having good credit can make it easier for you to get loans with lower interest rates, saving you hundreds on your monthly mortgage payments.

How crucial is your credit score in real estate? How would you rate your credit? Why is it necessary?

Your credit score, from 300 to 900, encapsulates your level of financial responsibility. You are more appealing to banks, mortgage brokers, and other lenders the higher your score is. From low to good, credit scores typically fall into categories like poor credit score: 300-574; fair credit score: 660-712; good credit score: 713-740; and excellent credit score: 741-900

When shopping around for a mortgage, aim for a fair credit score of 680 or above. It’s not always a precise science to determine the credit score required for mortgages; some lenders will work with borrowers whose scores are between 600 and 680, but they might charge them higher interest rates. Before applying for a mortgage, ensure your credit score is fair, outstanding, or excellent. The lender will consider you too risky to lend money if you don’t have a strong FICO score since they fear they won’t get their money back. Since getting their money back is every lender’s top priority, they are unlikely to take a chance on you if you have a poor history of repaying debts.

How do lenders see your credit score?

Your Credit Score represents your credit profile. Certain factors in different credit models consider how you have used your loans, credit cards, etc. 

If your credit score is high, lenders will choose to lend you money with the lowest interest rate feasible; otherwise, there are many chances that your loan will be rejected or the interest rate will remain relatively high.

In 2020, 620 is the minimum credit score required to purchase a home, while some lenders would accept 580 or lower. However, the likelihood that the lender will consider you is highly minimal if your credit score is 500 or less. You might still be able to purchase a home using a conventional fixed-rate mortgage if your credit is poor, but you will pay a higher interest rate and additional fees. A low credit score will ultimately cost you more money each month and throughout the loan.

Tips for investing in real estate with poor credit score

Investing in real estate is possible for those with poor credit.

1. Take the Federal Housing Administration loan

Its special financing was created to assist first-time homebuyers, requiring just 3.5% down rather than the standard 20%. So as you can see, an FHA loan would often be considerably better for first-time homeowners than a conventional loan. To qualify for an FHA loan, purchasers must have a credit score of at least 580. What do they do if, for example, their score is 575?

2. Consider partnerships

One of the various real estate legal companies you might create for investing purposes is a partnership. A partnership is a company that consists of two or more legal entities (or persons). It has the advantage that its members can complement one another. 

Because you might be more motivated, have superior business acumen, and have more time, someone with higher credit would partner with you. You can join a variety of partnerships, each of which has advantages. How much documentation, if any, is needed will depend on the form of partnership you select. Some partnerships might be informal, involving no papers and merely a verbal understanding.

• LLC-Partnerships

An LLC is a partnership with at least two members that is a legal and tax entity. These are perfect for real estate ownership since they offer numerous tax advantages and a lower chance of an IRS examination.

• Limited Partnership

LPs have a minimum of one general partner and one limited partner and are created by state limited partnership statutes. An LP is a pass-through entity, which means that income passes through it before going to the owners and investors of the LP. An LP files partnership tax returns and enjoys most partnership tax advantages. 

An LP, however, cannot offset any losses from rental property against other sources of revenue because it is entirely subject to passive loss limits.

3. Consider hard money lenders.

Hard money lenders are more concerned with the agreement’s security than the borrower’s credit score. They want to ensure they can foreclose on the property and sell it if the borrower defaults. Hard money lenders offer more stringent requirements in exchange for ignoring credit scores. Interest rates are between 10% and 18%. Loan terms range from six to twenty-four months.

Higher fees (“points”) can increase the loan amount by as much as 3% to 10%.

Since you don’t require a long-term loan for house flipping or the BRRR investing plan, a hard money loan’s short terms make it appealing. Search for local “hard money lenders” to discover one. Additionally, you might ask around at regional Real Estate Investors Association (REIA) meetings.

• Check the reputation of the hard money lender you choose.
• Request references.
• Check to see if the Better Business Bureau has received any complaints about the possible lender.
• Verify that at least one member of the hard money lender’s team holds a current real estate license that hasn’t been the subject of any complaints.

4. Consider private money lenders.

Hard money lenders frequently have experience in real estate. Contrarily, private money lenders are merely those who desire to invest their own money. This means that anyone could be your private money lender! Since a private money lender is unlikely to be an investment professional, they’re unlikely to ask for a credit score. You should avoid entering into such a deal unless you are confident you will be able to repay the investment because a private money lender is also most likely someone you know well enough to lend you money in the first place. It’s wise to avoid borrowing money from someone who can’t afford to lose it.

5. Consider house hacking

When you rent out your principal residence, this is called house hacking. 

Owners of multi-family homes that rent out vacant flats aren’t the only ones who engage in house hacking. Single-family homeowners may also rent out attics, basements, and bedrooms. House hacking is a practical method of risk reduction and income generation.

6. Purchase a Second Mortgage

You can receive a second mortgage if you own a home. Because a second mortgage will be secured by the property you already own, a low credit score has less of an effect. No matter the state of your investment property, ensure you have adequate revenue to pay the second mortgage. You risk losing your house and any investment property if you can’t make your payment!

7. Save money for the down payment.

You might be eligible for loans with lower interest rates if you can make an upfront down payment of 20% or more. This is because paying a sizable amount up front shows that you can handle your money and have stability in your finances. Even if the interest rate is high, you’ll still have enough cash to make your investment.

8. Consider a real estate investment trust (REIT) firm:

Property ownership and management are done through a real estate investment trust (REIT) firm. Publicly listed REITs allow you to participate in real estate with bad credit without taking on property owners because they are available for purchase and sale on the stock market. One of the extra advantages of REITs is that they have to pay out 90% of their taxable profits to shareholders.

9. Rebuild your credit

You should raise your credit score before, after, or in place of investing if you have no credit or terrible credit. Although it will require effort, doing so will improve your investing abilities, simplify investing, and aid in better money management. 

Consider the following tips.

• Making more money will help you deal with your debt more successfully. That could entail anything from putting in more time to finding new employment. You can take out a debt consolidation loan or enroll in a debt consolidation program to repay the loan too.
• Try to constantly lower your debt to less than 30% because a high debt-to-limit ratio hurts your credit.
• Stop requesting credit. Your rating suffers each time you apply.
• Consider getting a secured credit card. The amount you deposit with the lender determines the card’s maximum limit with a secured credit card. Your secured credit card’s limit will be $2,200 if you deposit $2,200. You may rebuild your credit more safely if you use this card for expenses like food, petrol, and other things you’ve already budgeted for.

Conclusion

You can invest in real estate with a low credit score. But that doesn’t mean you shouldn’t make an effort to improve your credit. Poor money management can lead to bad credit, which would make every investment you make risky. Therefore, be sure to continue working toward building good credit if you decide to adopt any of these investment options for people with bad credit.

About the Author: 

Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a principal attorney.