By Tammi Koza and Carl Phinney
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We recommend that real estate investors go through their credit reports on a regular basis. Carefully checking your report ensures you'll catch any fraud, ID theft, or reporting mistakes and can take steps to correct mistakes ASAP. You can obtain a free copy for your credit report from www.annualcredit.com.
When investing in real estate, it also pays to view your credit reports the way a bank would. Most people know the credit score is the first thing the bank looks at when reviewing a credit file, but few people know lenders also look at a host of other data, including credit availability, public records, and trade lines. What follows is a primer on what the bank sees when it pulls your file.
The three credit reporting agencies give each person a credit score based on a number of factors. Scores range from 300 - 850, with 850 being the best. Most banks take the average or middle of the three scores and call that your mid-FICO score.
The key here is to understand that lenders have different programs they can offer based on the FICO score. For the purchase of a primary residence, a 580 FICO is the lowest score you can have if you're going with a sub-prime lender to get 100% financing on a full-doc loan. (Sub-prime is the word used for those with less than perfect credit or a FICO score that's under 620.)
Rules of thumb for investment properties: You'll need a 660 FICO and no late mortgage payments to get 100% financing on a 1-2 family. For a 3-4 family, a 720 FICO is required.
The second biggest factor in determining your credit worthiness is your mortgage payment history. Your credit file will show if you were more than 30 days late on a payment. If fact, your file shows the lender's name and the mortgage amount with three columns labeled 30, 60, and 90. This format allows the bank to quickly add up the number of late payments.
If you were 30 days late, for example, a "1" shows in the 30-day column. If you were 30 days late twice, a "2" appears. Ditto for the 60- and 90-day columns. If you have one or more 30-day notations, you can still get financing, but those late payments significantly affect the type of loan program you can get.
What if your credit report is showing a late payment but you know you made every payment on time? Erroneous late payment listings on your credit report are more common than you think - and they need to be fixed, pronto. To rectify a reporting error, you can do the following:
One word of advice - don't destroy your check and mortgage statements! If your lender has gone out of business, you'll need these documents to prove you made timely payments. One client we had burned his statements each month, making it difficult to prove he had made his payments on time. Another lender failed to give the reporting agencies mortgage payment histories - which meant one of our clients had no mortgage history on his credit report!
As the name implies, a Rapid Re-Score is the fast method for correcting your credit report. Your lender or broker sends the supporting documentation to the credit reporting agency proving you made your mortgage payments on time. You will be charged per item and per agency to update the line items. Your credit score is then recalculated for the revised credit report. One client trying to close on a property was able to increase his credit score by 39 points once we recalculated it.
Banks like to see that you have a low debt to income ratio - less than 40% is ideal. To determine your ratio, add up all your monthly payments and divide by your monthly income. For example, if you have $2000 in debt payments and $4000 in income, your debt to income ratio is 50% -- which is considered high. Some sub-prime lenders, however, will go with 55%.
Any debts that have been passed to a collection agency will appear on your credit report. Before you refinance a property, Fannie Mae requires these collections be paid in full.
A bank looks at your credit file to determine if you've been taken to court for past "judgments" such as foreclosures or bankruptcies. These judgments will affect the type of loan you can get.
You don't need high credit limits to have good to great credit, but you should ensure your credit cards aren't maxed out if you're thinking of investing in real estate and want to go the conventional loan route. If you have $10K in available credit, and you've used $8K, this will negatively impact you. Banks also look to see you've made your credit card payments on time.
Additionally, a lender will look at your report to see how many credit or trade lines you have open and how long you've held them. Trade lines include student loans and car loans, in addition to credit cards. Ideally, you should have four trade lines that you've held for 24 months - with one line having at least $5K of credit availability.
Owning assets such as a 401k, IRA, stock portfolio, and/or cash reserves is important. However, as with trade lines, a bank looks to see how long you've held the asset. It won't help you to get $20K from Uncle Arthur two weeks before you apply for a loan. A lender wants to see six to nine months of seasoned assets in your name on an investment property transaction.
As a consumer, you'll also want to check your report for erroneous information the bank won't catch - such as merged information from someone else's report. If you have a common name, such as Tom Jones, you'll want to check that your information isn't being co-mingled with another Tom Jones.
Summary
Keeping your credit file up-to-date and accurate is your responsibility. Be pro-active by ordering a copy of your report from each agency, carefully reading through each line item, and quickly fixing mistakes when they appear. You'll rest assured knowing that future lenders won't find any surprises when you apply for a loan to finance that next real estate investment.
Tammi Koza is the Branch Manager for Family First Mortgage Corporation in Billerica, Massachusetts. Carl Phinney is the bank's Senior Mortgage Consultant and Operations Manager. Both can be reached at 508-966-5055 or by email at tkoza@comcast.net or cphinney@verizon.net.
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