Real estate investors, whether professional, part time, or first-time home buyers looking to move beyond a rental agreement, simply can't afford to have bad credit. Among the many reasons financially successful parents raise financially successful children is that they teach them the value of good credit, which can't be overstated.
Good credit is the difference between having to put down $40,000 versus $10,000 as a down payment on a $200,000 house, it's the difference between paying $1,537.83 for a $200,000 mortgage, and paying $1,104.41 for the same loan. It's the difference between driving a Corolla and a IS 250, it's the difference between the best local school system and mediocre one for your children.
How is credit calculated? How is it improved?
Credit bureaus use statistical models based on a relatively small amount of information to calculate credit scores. Some of these factors are well known, among professional real estate and rental investors, and among the general population, but others are less understood.
Probably the best known factor that's used to determine credit scoring is the frequency and extent of late payments. Borrowers who consistently make their mortgage, credit card, or other loan payments late are essentially flagged as unreliable borrowers, and lenders become reluctant to lend them money, because they're considered high risk borrowers. Make all of your loan payments on time, ranging from your car loan to your rental property's mortgage (regardless of whether your tenant paid their rental agreement this month), and you'll be doing yourself and your credit a huge favor.
Another well understood credit scoring factor is the existence of derogatory public records, such as foreclosures. Beyond just real estate foreclosures, however, public records that damage your credit include bankruptcies, tax liens, judgments, car repossessions, credit collection accounts, eviction filings, and any other "bad debt" that any creditor has ever tried to collect from you. If you failed to pay when you were supposed to pay, you can be sure that there's a record of it, and these public records badly hurt credit scores.
One scoring factor that is only partially understood by the public is the percentage of available credit that borrowers use. While it's true that having more credit is a good thing, in the eyes of the credit bureaus, it's only considered good if it's not used (or only minimally used). It's better to have less credit available, and use almost none of it, than to have a great deal of credit available, and to be near your credit limits on each account. For example, Pete has six credit cards, totaling $50,000 of available credit, but his total credit card debt is $46,000, which the bureaus don't like. His friend Suzy, on the other hand, only has $8,000 available in credit card limits, but she only charges a few hundred dollars each month on the cards, and pays off the balances immediately, which vastly improves her credit.
Another misunderstood credit scoring factor is the average age of your credit accounts. The older your credit accounts, the better, in the eyes of the credit bureaus, because they interpret that data to mean stability. So, only open new credit accounts as absolutely necessary, and keep your old credit accounts open if you only occasionally use them.
The middle- and upper-classes teach their children why credit is important, and it's one of the many lessons that make middle- and upper-class children grow up prepared to create their own wealth. Beyond simply creating wealth, however, it helps them live the absolute best lives possible with the resources they have, without having to waste a lot of money on finance charges, mortgage interest, or worse, rental agreement payments that don't lead to any ownership or equity. The rich aren't born smarter, their parents simply raise them to be smarter, and making the most of their credit is one of the many lessons imparted by savvy parents.
Brian Davis is a landlord & real estate investor, currently traveling the world and enjoying the benefits of his investments. He is also a contributing writer for NuWire Investor and EZ Landlord Forms, a supplier of custom rental agreement forms and state-specific eviction notice forms.
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