Essential Credit Score
Information for Real
Estate Investment
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.
Author-Bio: Jack
Sternberg
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