FICO Scores And Hard Money Loans: Why They Go Hand In Hand

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When growing a real estate investing business, having a good FICO Score is a key factor in obtaining capital and achieving the highest return on investment. Hard money or private money lenders use this score to determine if they should give a loan to the borrower and what interest rate they should set. In most cases, hard money lenders look at your FICO Score before pre-qualifying your application and approving your loan.

So, let’s take a look at FICO Scores, how it’s determined, and some steps you can take to improve your score over time.

Why is Your Credit Score So Important?

The FICO score is a very influential measure. It’s a range of just three numbers that can have major implications on your life. Those with higher scores tend to receive higher approval ratings and access to more favorable interest rates on loans.

Before getting started, real estate investors typically have one question loaded: how important is your credit score in real estate? The importance of a quality credit score should never be undervalued, especially for real estate investors. Great credit equates to better deals and money-saving tactics—which, in return, provides multiple options to finance real estate and navigate the mortgage lending process. The secret is understanding how a credit score is compiled and what factors affect it.

Having a good credit score can help save you money over time, as higher scores can lead to better loan interest rates and higher leverage. Generally, those with a FICO Score of 660 or above will likely be accepted for hard money real estate investment financing, while those with a score of 720 or higher may be eligible for the lender’s best rates.

With an exceptional credit score, you can enjoy: 

• A better chance for loan approval
• Easier pre-qualification for financing
• Lower interest rates
• Getting approved for higher credit limits
• Bragging rights

Credit Score Categories

A FICO credit score is a number between 300 and 850 which is used to measure a borrower’s creditworthiness and their level of risk to a lender. This range into five categories: Poor, Fair, Good, Very Good, and Exceptional. 67% of Americans fall into the Good or higher range.

• Poor (less than 580). A score in this category is well below average, and these borrowers are considered to be risky.
• Fair (580 to 669). This range is considered Fair on the FICO scale. Some lenders may approve these borrowers, though they likely won’t offer them good terms.
• Good (670 to 739). FICO Scores in this category are at or above the national average. Most lenders are willing to finance these borrowers.
• Very Good (740 to 799). A Very Good FICO Score is above average and shows lenders that the borrower is low risk and likely to remain in good standing.
• Exceptional (800 to 850). These borrowers will most likely get approved and access the most competitive rates and other loan terms.

What Affects Your Credit Score?

Having a knowledge of what a great FICO Score looks like, let’s now evaluate the aspects that influence your credit score. Taking measures to enhance your score is only possible once you know what goes into it. Generally, your FICO Score is affected by five main elements, each with its own effect, considering both positive and negative details in your credit report.

• Payment History (35%): Payment history is what most impacts your credit score. Payment history comprises several factors like the number of late payments and public records like lawsuits and bankruptcies.
• Amounts Owed (30%): A reflection of all the money the individual owes, showing the total of all outstanding balances.
• Length of Credit History (15%): The amount of time you have had credit can impact your credit score—the longer your credit history, the better your score is likely to be. Creating a good credit history can be difficult, particularly for people just starting out.
• Credit Mix (10%): Having various credit account types on your credit report could help you improve your credit score. This could be done by obtaining different types of credit, such as credit cards (revolving credit) and installment loans. Making payments on time for any new accounts you open can also help you build a good credit history.
• New Credit (10%): This factor refers to the age of your new credit. If your credit history shows several new accounts and hard inquiries, your credit score could drop, and lenders may consider you a less desirable borrower.

What Role Do FICO Scores Play in Getting Hard Money Loans?

A hard money loan is an ideal financing choice to make the most of a new investment property purchase. However, your credit rating must be decent to get such a loan. This is because the lender needs to safeguard their investment.

For borrowers wanting to get a hard money loan, their FICO Score is an important factor that can either positively or negatively influence the approval of the loan. It is a way for the lender to assess the risk associated with the loan and ensure they will get the money back they are loaning out.

Some private money lenders like Kiavi will do a soft credit pull to look at your FICO Score as part of its pre-qualification process. Unlike hard inquiries, soft inquiries won’t affect your credit score. On the other hand, some will make a hard inquiry to take a deeper look at your creditworthiness. You should ask your lender about their process before applying for a hard money loan.

The relevance of FICO scores to obtaining hard money loans is two-fold. On the one hand, a higher score suggests that a borrower is reliable and less likely to miss payments, therefore saving both parties money. On the other hand, having a low or nonexistent FICO score may make it challenging to be approved for any type of loan. Fortunately, there are steps you can take to raise your score.

Ways You Can Improve Your Credit Score

With the knowledge of what influences your FICO credit score, the following five steps can help the rating increase in a positive way. These steps target each of the primary components mentioned previously.

Check your credit reports

Studies have found that a quarter of people have found errors on their credit reports that can negatively impact their credit scores. This is why it is extremely important to review your credit report to ensure that everything is accurate and up to date. Doing this can help you identify any issues and make the necessary improvements.

Every year, you have the right to obtain a free credit report from each of the three main consumer reporting agencies (Equifax, Experian, and TransUnion). You can also get a copy of your report from AnnualCreditReport.com.

It is important to carefully review your report’s details to ensure accuracy. If there are mistakes, you can dispute them by getting in touch with the relevant bureau(s) and having them corrected. This could help to improve your credit score quickly.

Improve your payment history

Your payment history influences your credit score the most, so you should focus on improving this first. Missing or being late on payments can have a long-term negative effect lasting for seven years, so if you have a past of making late payments, it is crucial to alter this behavior immediately.

Ensuring payments are made on time is simple—set up automatic payments to your revolving credit accounts. This can be done through your bank or the creditor, but be sure to have enough funds in the account each month to cover the bills. If not, you could be charged for insufficient money and late payments.

It’s preferable to pay off your full balance each month. However, if this isn’t possible, making the minimum payments on time each month will ensure that your accounts are in good condition.

Manage your credit utilization

An important part of determining your credit score is the ratio between the amount of debt you have and the total amount of credit you can access. This is known as your debt-to-credit ratio or credit utilization and should be managed carefully.

A low credit utilization rate benefits lenders, demonstrating that you are reliable and not over-borrowing. FICO’s analysis of people with a score of 785+ found that they had an average utilization rate of 7%. This indicates that the less credit you use, your score could be higher. 

A 7% utilization rate is a good target to aim for when working on increasing your credit score. A potential way to improve your credit score is to request a higher credit limit from your creditors. Although this could help you reduce your debt-to-credit ratio, it could be risky if you are an impulsive shopper. To make this strategy successful, be accountable for your spending and be aware not to overspend.

Be aware that closing multiple accounts can negatively impact your credit score—this includes reducing your credit utilization and shortening the average age of your accounts. Additionally, it is important to keep in mind that when you close an account, it reduces your overall credit availability. Be cautious when canceling accounts to ensure you do not unintentionally damage your credit score.

Tend to collection accounts

If payments are not made on time, they can appear on your credit report as a damaging remark and remain there for seven years, reducing your credit score. If the debt is transferred to collections, the account will be marked as such, and your credit score will take a big hit. However, if you start making more responsible financial decisions, the negative effect on your score will gradually decrease.

Having a good credit score and financial well-being is important, so addressing any issues with creditors and debt collectors is key. You should review your credit reports if you’re unsure who to contact or how to pay off old collection accounts.

Before paying a lender, you should request a debt verification letter to make sure that you are the one being asked to pay. Also, double-check the balance and contact the original debtor to ensure you are working with a legitimate collection agency.

Longer credit history

Having a long history of managing credit responsibly is a great way to boost a credit score. Keeping your oldest accounts active is essential to this, as the age of your credit accounts is considered. Be aware, however, that certain banks may cancel older, inactive accounts, so make sure to use them regularly to avoid this.

A diverse credit mix

Having a good credit mix is beneficial for your credit score. This includes having a combination of installment and revolving credit. Installment credit includes mortgages, student loans, auto loans, and personal loans, while revolving credit includes credit cards and lines of credit. Experian, one of the main credit bureaus, suggests that it is good to be mindful of your credit mix when trying to improve your credit score.

New credit

It is important to be mindful of the number of new accounts you open or apply for. This does not mean that you should not open any at all, but you should be careful not to open too many simultaneously. FICO states that when you open multiple accounts in a short period of time, it could be seen as a higher risk, especially for people who do not have a long credit history.

Be cautious of having too many hard inquiries in a short period of time. This kind of request usually happens when you are trying to get a loan or credit card. It means the lender is asking to review your full credit history to assess your financial risk.

Hard inquiries will stay on your credit report for two years and will change your FICO Score for one year. As mentioned, ask potential hard money lenders if and when they do hard credit pulls before applying.

Lenders may look into your credit history without it having a negative effect on your credit scores, known as a “soft pull,” which can be used to decide whether to pre-approve you for a loan or credit offer before you apply.

Final Thoughts

Having a quality credit score is important for real estate investors because it is often one of the first things lenders will ask before providing a loan. When working with hard money or private money lenders, a good credit score can go a long way in landing your next deal.

That being said, how important is your credit score in real estate? It’s important, but there are ways to work with what you have. Research the above financing methods as you improve your credit, and you will be well on your way to building a successful real estate portfolio.

It takes time and dedication to raise your FICO Score, and the rewards can be great for real estate investors. To stay financially healthy and maintain a good score, it is necessary to use credit responsibly and practice good financial habits. These habits will help you maintain a solid credit history.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.