Your credit or "FICO" score is vital to your real estate
investment career. It's no secret that the higher your
credit score, the better the chances of your obtaining
loans and getting them at a lower interest rate. It keeps
money in your pocket!
Remember this essential fact: lenders are in the business
of loaning money and loaning it at the lowest risk possible
so they're going to look hard at your credit score before
pulling cash out of their own pockets. This information
tells you should understand how credit scores are
calculated and what you can do to raise your own credit
score if it's low. This article provides you with that
vital information Background on Credit Scores So, what
exactly is a credit score? Simply put, it's a formula used
by lenders and others to give them an objective method to
predict how likely it is that you will repay a new loan. A
credit score is the result of complicated formulas for
rating your credit worthiness.
You'll often hear a credit score referred to as a "FICO"
score. This term comes from two men named Fair and Isaac.
In 1955, they founded a company called Fair Isaac
Corporation. Over the years, the name got shortened to
"FICO." Fair, Isaac is a for-profit company, traded on the
New York Stock Exchange (NYSE: FI). Their exact formula for
calculating credit scores is proprietary; that is, it's
secret.
Each of the major American credit reporting agencies (CRAs)
has a relationship with Fair Isaac. The three major CRAs
are: Experian, Equifax, and TransUnion.
Now, you'd think that each CRA would have the same score
for each person, but they have different models for
determining your credit score so your score may vary from
one CRA to the other!
In any case, they're still referred to collectively as
"FICO" scores. Each model is based on experience with
millions of consumers. With each model, the higher your
score, the better your credit rating. Calculation of Credit
Scores A credit score depends on the credit scoring model
used by the CRAs. In general, FICO models look at these
items in your history: Past delinquencies Derogatory
payment behavior Current debt level Length of credit
history Types of credit Number of inquiries by lenders
and others into credit history.
Although the models vary, the general formula looks like
this:
35 percent on a borrower's payment history. 30 percent on
debt. 15 percent on how long the applicant has had credit.
10 percent on new credit Another 10 percent on types of
credit.
There is a range of FICO scores. Within that range, the
higher the score, the better your credit rating is. For
example, a perfect score is 850 (only 1% of the U.S.
population). Eleven percent (11%) of the population has a
score of 800. In the above two instances, the borrower
likely will get a lower interest rate and have the loan
closed within days.
The average person has a FICO score of 720. The interest
rate will be higher, and it'll take days or weeks to close
the loan.
If your FICO score is less than 600, then you're definitely
going to have trouble getting money from conventional
lenders. That's because lenders calculate you'll default on
that loan better than 50% of the time. Naturally, it
doesn't make good business sense to lend money in that
situation. Or, if they do loan the money, it will be at a
much high interest rate in hopes of covering the risk.
Lenders very carefully look at "red flags" to decide
whether or not to give loans to individuals with low credit
scores. Red flags include: missed payments, late payments,
unpaid debts, bankruptcies, etc. Common-sense Guidelines
for Raising Your Credit Score The first guideline is to pay
your bills on time—all the time. The second guideline
is to not open unneeded credit card accounts to increase
available credit. That raises red flags for lenders. The
third guideline is to budget to figure out where you're
currently at financially. The fourth guideline is to reduce
unnecessary expenditures so you can apply that saved money
to your debt and improve your credit score.
If you're not sure what your current financial situation
is, you can analyze it using the debt to income ratio
formula. It's a simple method of measuring your net
monthly income against your debt.
Here's an example: Assume your net monthly income is $2000,
and your monthly debt payments are $500. Now, divide $500
by $2000, and you've calculated your debt to income ratio:
500÷2000 =.25 (25%).
It's generally agreed that debt expenses should be 25% or
less of your income. A ratio of 10% or less is great.
Anything above 25% is a red flag for you and may be for
lenders. If it's 25% or more, you definitely need to reduce
or eliminate debt!
To calculate your current debt to income ratio, take the
following steps: Look at last month's bills and add up all
the fixed expense items (rent, mortgage, car payments,
child support, loan payments, etc.). Then, check your
credit card bills and add up the minimum payments owed on
each card. Figure out your monthly take-home pay (net
salary). Divide monthly fixed expenses by monthly income.
Key Point: A good credit score is essential for your real
estate investment career! If it's low, do everything you
can to raise it.
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Jack Sternberg is a nationally recognized expert on real
estate investment who's been in the business for more than
30 years. Sternberg is the creator of the renowned "Buyers
First" Program. His deals have totaled over $750 million
and he's been to the closing table more than 1,500 times.
For more, visit http://www.askjacksternberg.com
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