Every real estate entrepreneur quickly learns that establishing good credit is essential for structuring sound and profitable real estate deals. Whether you are searching for long-term financing for a new rental property or looking for short-term funds for a fix up, your success may very likely be tied to your ability to secure loans with lower interest rates and great terms.
Lenders will evaluate your ability to repay these loans based to a large degree on what is known as your “credit score”. This credit score is also referred to as your FICO Score. This term has become common place in the finance community because the software used to calculate the credit score was developed by the Fair Isaac Corporation (FICO). Since 90 percent of all commercial lenders use the FICO Score to determine an individual’s ability to repay a loan, it makes sense for the real estate entrepreneur to improve his or her credit score as much as possible.
Creditors make their decisions based on your credit score. The credit score is determined based on five factors. Payment history accounts for approximately 35% of the score; amounts owed for approximately 30%; length of credit history approximately 15%; total amount of credit approximately 10%; and types of credit approximately 10%. You can’t hope to improve your FICO Score unless you know what that score is. Start immediately by obtaining a copy of your credit report. You can contact the major credit reporting bureaus, including: Equifax, Experian, and TransUnion. There are also numerous resources for obtaining a free copy of your personal credit report. Simply log on to one of the major search engines and search for “FREE CREDIT REPORT”.
Strategy #1 – Obtain and Review Your Credit Report
Once you have access to your credit report, you need to commit yourself to reviewing the information contained in the report. It’s possible that some of the information provided by the banks, financial institutions, and contributing companies could be in error. It’s also possible in today’s climate of identity theft that your identity could be used in fraudulent transactions. If you identify any errors, you need to call and contact the contributors to correct any mistakes that you identify. In some cases, a simple contact by phone might immediately improve your credit score.
When you contact these companies, you must be aware that you will need to provide evidence of who you are and why the item you dispute is incorrect or outright false. One entrepreneur recently reviewed his credit report and found that his score was negatively impacted by failure to pay alimony and child support. He was quite surprised because he had never been married or fathered any children. In his case, he had been misidentified because there was another man with the same name and the social security numbers were mixed up.
This action of reviewing your credit report should be done on a regular basis as new entries on your credit report are constantly being added.
Strategy #2 – Immediately Improve Way You Pay Bills
Your credit score is determined by five major factors starting with the payment history. Approximately 35% of a credit score is based upon the history of the payments made on past and present bills. This being the case, you need to take preemptive steps to maintain good payment practices or improve slow or late payment practices. When you review your credit report, you will notice immediately the impact of late payments. If that’s the case, now is the time to turn that trend around.
Start by the simple act of making a schedule of when you pay your bills and then pay the bills on time. It helps to make a list of all your bills and the due dates on regular bills. An added benefit is that you see in real terms what how much of your income is going out on regular bills.
Consider signing up for automatic payments on regular occurring debt. The advantage of this is that your bills are paid promptly, and in many cases, you will get better terms from the lender. Make sure that you have the funds on hand in the accounts you use to fund these automatic payments.
There may be times when you as an entrepreneur find yourself in a financial situation where you can’t avoid a late payment. Avoid these situations whenever possible, but if it happens, make sure that you never let the late payment go more than 30 days. Some lenders don’t always report late payments up to 30 days, but all report late payments that are 60 days late. Above all, don’t make a habit of being late even for a few days on bills that become due.
Strategy #3 – Manage Your Personal Credit
Approximately 30% of your FICO Score is based on the amount owed by an individual. Your first objective is to avoid opening new credit accounts. In today’s world, you are offered incentives to open new credit accounts on a constant basis. Even if you don’t plan on using this credit, the newly opened credit account will have a negative impact on your credit score. Despite the credit account being open, the lender may believe that you may have future problems in reducing or paying off the debt.
Next focus on paying off credit cards. Credit card interest is usually the highest interest rate charged for a loan. When you have credit cards, try and pay off the loan as rapidly as possible, and once you have past credit card amounts paid, attempt to pay off the balance entirely when it comes due each month. This will help raise your credit score right away.
It’s entirely possible to get into the position of having high credit card balances, but doing so will create problems with your credit score, while having a negative impact on your ability to make good real estate deals. If you do have a balance on your credit card, it’s been found that you want to keep your credit card balance at approximately 30% of the card’s available credit. This means, in simple terms, that if you had a credit limit of $10,000, you would not want to have a balance of more than $3,000.
Strategy #4 – Start Eliminating Debt
Naturally we all want to get out of debt. When we do so, we have a much more enjoyable life, but it also allows us to increase our credit score. There is a difference between investment debt and personal debt. Your credit score can actually increase when you are purchasing a home. If you haven’t had credit in the past, you will want to establish credit by purchasing an automobile or some other asset on credit. The key is to establish the credit and then to pay it off. It has been shown that if you maintain the loan and make regular payments for at least 8 months, you can establish regular payments. Once you have established credit, start getting rid of as much debt as possible.
The first debt you want to immediately eliminate is credit card balances. You should now be aware that these unpaid balances on credit cards will reduce your credit score. Some entrepreneurs want to cut up their credit cards, which will help if you are overspending, but credit cards you’ve had for a long period of time that are paid off or have zero balances help your credit score.
When you have a lot of unused credit available and not using it, your credit score will improve.
Strategy #5 – Establish and Maintain an Emergency Fund
Financial advisors have suggested for decades that it’s always wise to have an emergency fund that will pay for dry periods when you can’t meet a portion or all of your financial obligations. The ideal amount seems to be six months of your annual income. This may seem daunting at first, but if you learn to budget, it’s achievable over time. In order to build up an emergency fund, you will need to learn to live on a budget.
Six months of emergency funds won’t happen immediately, but if you start with the goal of having one month and then two, it can take place. Once you have the reserve to meet your regular budget needs, and especially your debt payments, live itself becomes much better. Your credit score with naturally improve.
The different credit bureaus have different ranges, but they all seem to be fairly close. Experian uses the following range to evaluate scores:
Improving your credit score takes work and time, but the rewards for the real estate entrepreneur can be amazing. With a better and improved credit score you can qualify for better interest rates, get faster approval on loans, and open the door for bigger and better real estate deals. You can improve your credit score with discipline, and when you do, you will have access to better and better deals.