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4 Things You Probably Don't Know About Credit
By Debbie Siegel
Credit. In 21st century America, it makes the world go around. Whether
it's the purchase of an investment property or the purchase of a pair of
shoes, we are increasingly becoming a cashless, pay-it-later society.
As a property investor of course, that's good news. More financing
options are available today than ever before, giving you the opportunity
to get in the game with less money down and with fewer restrictions than
in the past.
And when you boil it all down, it's your personal or business credit
worthiness that sits at the heart of this new world. You can't buy the
property if you don't have the money, and credit is the staring point from
which lenders of all types and sizes will decide whether or not you are a
good risk.
If you're like most investors however, you're probably unaware of the
behind-the-scenes, potential "gotchas" that can come into play when you
apply for a loan or mortgage. That's what I want to share with you today.
* Next 37 17 investors only!
Four things you probably don't know about credit:
- It's easier to get financing on your primary property than on an
investment property.
The reason, of course, is risk. Lenders know that when push comes to
shove, any reasonable person who finds himself in a cash crunch will pay
the mortgage on the home he lives in before paying the mortgage on an
investment property. As a result, lenders make the bar a little higher
and require that you be a bit "stronger" as a borrower when borrowing to
invest.
In practice, this may play out in a number of ways. For example, your
lender will require a higher credit score from you (see our Interview with
The Expert for more on credit scores). Whereas the credit score bar may
be set at 620 for a loan to be considered on your primary residence, it's
may be at 660 for an investment.
Similarly, the lender will look for a lower debt-to-income ratio for an
investment. So while all of your income is considered when deciding how
much you can handle for a primary residence purchase, with an investment
purchase, only 75% of the anticipated rental income will "count" as
income. It's just another way for the lender to manage risk.
It's also worth noting that regardless of your particular
creditworthiness, you can expect to pay at least half a percent more for a
loan on an investment property than for the same loan on your primary
residence.
- Just paying past due accounts current doesn't erase them from your
score.
If, for example, your Visa bill is two months behind and you bring it
current in preparation for a loan, your credit score won't instantly be
fixed. It can take as long as 60 days just for the update to reach the
credit bureaus.
Even then, the fact that you were behind is still a mark against you.
Most underwriters don't want to see anything late in the past 12 months
(especially a mortgage payment), and while it certainly makes sense to
bring past due accounts current, these payment issues stay with you for a
long time.
- Recent delinquencies hurt you more than large dollar amounts.
Last month I pulled the credit score for one of my clients in preparation
for a loan application. He was just $25 behind on a store credit card
payment, and yet this negatively impacted his credit score more than a
previous delinquency from a year ago for a much higher amount.
Although at first glance this may seem counterintuitive (Shouldn't the
dollar amount matter more than anything else?), if you think about it, it
actually makes quite a bit of sense. If a lender is going to lend you
money today, they are most interested in your financial life today.
Problems from the past are less predictive of future behavior than current
delinquencies - even if the dollars (or balances) are small.
- Credit utilization matters.
Credit utilization refers to how much of your available credit you're
using at a given time. If you have five credit cards for example, with a
$5,000 line on each, and you've got $4,500 in play on all of them, that's
considered a negative. Even if you pay them all on time, the fact that
you are close to the maximum on the credit you've been granted makes you
look risky. A potential lender may view this as an indication of cash
flow issues or excess spending.
As a practical matter therefore, I recommend getting your credit card
balances to a 35%-45% utilization (paying down on your cards) in
preparation for a loan application. By having credit in hand that you
don't use, your application will be looked upon much more favorably.
In summary, there's a lot that goes on behind-the-scenes in the world of
credit approval and lending. As a real estate investor, it's important
for you to understand the system, so that you can close the deals you want
to close, as quickly and profitably as possible.
Debbie Siegel is a mortgage broker with a focus on removing anxiety from
the lending process. She is president of Westchester Mortgage in Newton,
Mass. Debbie is licensed in several Northeastern states and can be
reached at Debbie@westchester-mortgage.com or
617-965-1236.
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