In this article, we examine the options available to investors in terms of credit repair for the mortgage approval process. Credit score is a vital component of the standard mortgage approval process. This applies to both conventional financing and loans for investment properties. Even though lenders offering DSCR loans or hard money loans do not take metrics like DTI into account, they still pull borrower credit scores as a part of the underwriting process.
Creditworthiness directly correlates with the rate, terms, and overall structure of a loan that mortgage lenders are willing to offer. Oftentimes, having a credit score that is too low will disqualify a potential borrower from being able to secure a loan. For those with a less than ideal credit history, working to repair one’s credit score can seem like a daunting task. Fortunately, there are proven ways for borrowers to improve their credit score and better position themselves to qualify for a mortgage.
Do Private Mortgage Lenders use Credit Score?
As a private mortgage lender solely providing loans for investors (i.e. non-owner occupied properties), Easy Street Capital is primarily concerned with the value of a property and its revenue potential. The EasyRent program, for example, provides Debt Service Coverage Ratio (DSCR) loans. DSCR loans are mortgage loans secured by residential real estate turnkey properties strictly used for a business purpose and underwritten primarily based on the property. In contrast to conventional financing, these loans focus on the cash flow of the property, rather than the borrower’s income. DSCR loans do not take a borrower’s Debt-To-Income (DTI) ratio into account.
Since loans are qualified on the basis of a property’s cash flow, there is a misconception that credit score is unimportant. This could not be further from the truth! Credit score is actually one of the three key metrics in determining your interest rate. While an individual’s creditworthiness is not the primary concern for this loan product, credit score has a direct impact on the interest rate a lender is willing to offer. Higher credit scores lead to lower interest rates – meaning lower monthly payments and higher cash flow!
Understanding Your Credit Score from a Lender’s Perspective
Before diving into credit repair strategies, let’s establish a baseline understanding of what your credit score is, and how lenders use this information. In the context of the mortgage industry, lenders pull a borrower’s credit to assess potential risk of lending to an applicant. Ranging from 300 to 850, your credit score serves as a prediction of your credit behavior (ex: how likely you are to pay a loan back on time) based on information from your credit report (Consumer Financial Protection Bureau). Borrowers may also hear this number referred to as a FICO score. This is a specific brand of credit score introduced by Fair Isaac Corporation (FICO) in the late 1980s. FICO score is determined by assessing credit data in the following five weighted categories: payment history (35%), credit utilization (30%), length of borrower credit history (15%), types of credit in use (10%), and new credit accounts (10%).
The three nationwide reporting bureaus are Equifax®, Experian™ and TransUnion®. Mortgage lenders take credit scores from all three bureaus into consideration by pulling what is commonly known as a tri-merge credit report. For mortgage approval, a good credit score is crucial, as it directly influences the interest rate offered and the increase the likelihood of loan approval. Federal law grants individuals the right to a free copy of their credit report every 12 months from each bureau. The Federal Trade Commission outlines how to order these reports online, over the phone, or by mail.
What is the minimum credit score required for an investment property loan?
Most private mortgage lenders will require a minimum credit score in the mid to upper 600s (660-680). Depending on the type of loan you are seeking (and the lender you choose to work with), minimum credit score requirements can be even lower. For example, our EasyFix lending program for fix and flip loans requires a minimum credit score of only 600! However, a score falling at or near a lender’s credit minimum usually means the potential borrower’s options in terms of loan structure are limited.
Improving Credit Score for Mortgage Approval
If your credit score has prevented you from obtaining approval for a mortgage in the past, there are a number of critical actions you should take to begin improving your score. Start by obtaining a copy of your credit report. Familiarize yourself with what appears in your report and look for any errors or inaccuracies. If you do happen to identify anything incorrect in your credit report that appears to be adversely affecting your score, you should file a dispute with both the credit reporting company AND the company associated with this incorrect information.
After reviewing your credit report for information that is flat-out inaccurate and filing disputes with the appropriate parties, it’s time to start taking action on an individual level to improve your score. As you can probably guess based on what you’ve read so far, you should use the five previously discussed factors that influence your FICO score to guide your actions.
Payment History
Payment history is objectively the most significant component of your credit score. Making (at least) the minimum payment on all accounts each single month is the quickest way to improve credit given the importance this factor plays in determining your score. Each instance of a missed payment on an account is going to hinder your score. Borrowers should also keep in mind that payment history not only takes into account whether a payment was missed or made. It also looks at how quickly you make a payment on a delinquent (late) account as well as how long on it takes you on average to make a late payment.
In order to improve your payment history as it relates to your credit score, you must strategically manage existing debts. Reduce credit card balances and avoiding opening new lines of credit. If past-due accounts are present, work to bring them current or negotiate settlements.
Credit Utilization
What is Credit Utilization Ratio?
Credit utilization ratio is calculated by adding up active balances across all accounts and dividing that number by total available credit. The simplified example below demonstrates how this ratio is calculated:
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- Credit Card 1: $5,000 limit, $1,500 balance
- Credit Card 2: $20,000 limit, $9,500 balance
- Credit Card 3: $15,000 limit, $3,000 balance
In this scenario, your total available credit would be $40,000, the sum of credit limits across all accounts. By doing the same for your active balances, you get a total of $14,000. Dividing your credit used by total credit available gives you your credit utilization ratio – 35.0% in this case.
The lower your credit utilization ratio is, the better your credit score will be. While everyone’s credit history is unique, the general rule of thumb is to aim for a credit utilization ratio of 30% or lower. Maxing out credit cards or carrying high balances on a credit line will have negative impact on your score. Making consistent, timely payments will help you avoid accumulating large balances. Think strategically when prioritizing which credit lines you should address. The interest rates associated with each of your accounts is an incredibly important factor in this decision making process.
Length of Borrower Credit History
Since mankind has yet to discover a functional method of time travel, this is arguably the credit score component that you have the least control over. Obviously, lenders are more comfortable lending to borrowers with a proven track record of timely payments over the course of years, or even decades. There’s no groundbreaking guidance to offer in this regard. If you have historically made all of your payments on time, continue to do that. If you haven’t, review all of your active accounts on your credit report and develop a plan to better position yourself to make timely payments moving forwards.
After reviewing your credit report, if you identify an unused open card, resist the urge to close out the account. Instead, make small purchases each month (think $20 or lower) with unused or underutilized cards. Once you make your small monthly purchase, pay off your bill immediately to avoid forgetting about the charge. This approach will actually kill two birds with one stone. Rather than closing out an unused card, you are building credit history of complete, timely payments AND lowering your overall credit utilization ratio.
Types of Credit in Use
Having a variety of different accounts on your credit report will generally have a positive impact on your score. This diversity of accounts is also known as your credit mix. Please note that this statement does not exist in a vacuum. The best practices outlined in the preceding sections still apply. Common types of credit accounts that will appear in a credit report include automotive loans, credit cards, installment accounts, mortgages, and student loans. There are also accounts that will negatively impact your score such as collections or public records accounts (think bankruptcies, tax liens, etc.).
This aspect of your credit score correlates somewhat with what stage of life you’re in. You definitely should not go out and open up a bunch of new accounts just for the sake of diversifying the types of credit that will display on your report. Opening numerous accounts in a short time frame negatively impacts your score. Ultimately, you should have an understanding of the credit mix reflected in your report. It’s not necessarily something that needs to be addressed right away as it has a lower level of influence on your score. Additionally, if you were to attempt to improve your credit by focusing solely on this aspect of your score, more times than not you will do more harm than good.
New Credit Accounts
Unless absolutely necessary, you should avoid opening a number of new cards and/or requesting an increase in your limits in a short period of time. From a lender’s perspective, this is a sign that a borrower is struggling financially and in dire need of additional credit. It’s important to note that getting a new card to transfer balances also falls under this umbrella. These days, many airlines or stores offer enticing card accounts associated with some discount or promotion. While the perceived benefit may seem appealing in the short, these sorts of accounts will ding your score.
If you have been denied mortgage approval in the past due to your credit score, you should avoid opening new accounts at all costs. In most cases, opening new cards/accounts while actively working to repair your score is essentially shooting yourself in the foot.
Understanding Credit Repair for Mortgage Approval
Credit repair is not an insurmountable task as some may perceive it to be. You just need to be systematic in your approach to resolving and missteps in your credit history. Begin by reviewing your credit report and addressing any inaccuracies with the appropriate parties. Then, use the five factors previously discussed to establish a game plan for rebuilding your score. Included below are some general principles you can follow in a more digestible format:
Pay your bills
Always pay your bills in a timely manner. For accounts paid by mail, plan accordingly and send payment out early.
Work to keep your credit utilization low
Do not max out your cards. Actively work to lower any active balances. If applicable, you can reach out to your credit card company to request an increase in your credit line. Assuming your credit history with the company is satisfactory, you will likely be granted an increase. In these cases, keep your monthly spending where it has been historically, which in turn will both lower your credit utilization AND improve your score.
Reduce high-balance accounts
This may not apply to every scenario depending on interest rates associated with the accounts. You should, however, try to chip away at your high-balance accounts early on so that the balance doesn’t continue to accumulate.
Keep older unused or underutilized accounts open
Resist the temptation to close these accounts. Purchase one small item each month and pay off the balance immediately. This method continues to build your credit history while also lowering your credit utilization.
Avoid opening new accounts
Especially in the context of seeking mortgage approval, you should focus on the task at hand. Opening new accounts will bring your score down in the short term. This could also open the door to more potential issues if things don’t go according to plan.
What are my next steps?
There is no fixed timeline for credit repair. It depends on several variables, including the severity of the credit issues, the types of negative entries, and the proactive measures taken to address them. While likely not the answer you were looking for, it is the truth. You can read more about general guidelines on when to expect changes in score to occur in our article on repairing credit with a mortgage past due.
It’s essential to consistently practice good financial habits, including making on-time payments, reducing outstanding debts, and managing credit responsibly. Additionally, regularly monitoring your credit report for accuracy and addressing any discrepancies promptly can expedite the credit repair process.
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