Archive for 'Real Estate Investing'
Easy Money?!
June 3rd, 2010. Published under Credit Scoring, Home How To, Home Improvement, Mortgage Guidelines, Real Estate Investing. No Comments.
As an organization that works with rehab investors, we are often asked, “What is the number one mistake that rehab investors make?” The answer is the same for seasoned veterans and “newbies” to the rehab investor scene.
Many would assume the answer is they paid too much for a property, underestimated costs due to surprise repairs, or hired bad contractors that took too long to complete the project. Although these are all examples of issues that can arise, the number one mistake that rehab investors make is using consumer debt for business purposes because it is “Easy”.
On the surface, the lowest hanging fruit for a rehab investor is the credit card or Home Equity Line of Credit (“HELOC”). Often these consumer credit facilities are used for repairs and even purchases of real estate. Why go through the hassle of gathering information and approaching lenders for a loan that they will charge points, fees and potentially higher interest when you already have or can easily obtain a credit card or HELOC? The short answer is that using consumer financing for business purposes does not work long term. In fact, it can be lethal for you as a business operator and a consumer.
Specifically, this “Easy” financing methodology can have a very negative impact on credit scores. For entrepreneurs in the rehab investor market segment where capital availability is a critical success factor, the credit score is your most valuable asset. It must be protected.
A credit score is determined using five main methods of analysis.
Payment History
First, one’s past payment history drives the credit score. If you make your payments on time, then it will help your credit score. If not, then your score will be hurt. This has the most impact, accounting for 35% of your credit score.
Amount You Owe
The second factor is the amount you owe in relation to the credit limit. It is also known as the utilization rate. If you have borrowed and are near or at your credit limit, this damages your score. In fact, any balance above 50% of the limit has a negative impact on the score. This is important for rehabbers because financing rehab projects takes a great deal of capital, which will most likely exceed that ratio. High unemployment and the decrease of home values have prompted many lenders and banks to cut credit limits in order to minimize risk, resulting in an immediate increase of utilization rates. This accounts for 30% of your credit score.
Length of Credit History
Third is the length of your credit history. If you have only had credit for one year, it hurts your credit score. If you have had credit for many years it will help. This can impact 15% of your credit score.
New Credit
The fourth category, the amount of new credit you have, can hurt your score too. If you continuously apply for new credit cards, this shows up as a red flag on your credit report. Credit scoring agencies often view this as an act of desperation. Thus, opening up new lines of credit to pay off existing ones will still damage your score. This is also important, accounting for 10% of your credit score.
Type of Credit
Finally, the types of credit you have can impact your score. Again, more credit is not good. Of course you will have mortgages, consumer-related credit card debt, student loans and other kinds of credit. However, having many kinds of credit card debt can hurt. This comprises 10% of your credit score.
Why Does It Matter?
The category of analysis that can impact rehab investors the most is the second type—the level of credit used compared to the credit limit. This accounts for 30% of your credit score. According to FICO Score Simulator, maxing out your credit cards could drop your credit rating from 700 down to 590 or worse, assuming that you still pay your bills on time and all other factors remain positive. According to myFico, “Carrying extremely high balances on all of your revolving accounts (i.e. credit cards, equity and personal lines of credit) makes you look ‘maxed out’ on your available credit. It is often considered a high-risk trait by lenders and the FICO score.” In short, lenders (and credit scorers) don’t like high balances.
So how do credit-reporting agencies distinguish between a shopping spree and a rehab project?
Well, they don’t. It is hard to blame them, however. This is because they report on 190 million consumers. Extremely few of these 190 million people are rehabbers, so it is impossible for credit bureaus to track the difference between consuming and investing on credit cards. When you purchase and pay for improvements on a property with your credit card, the agency cannot distinguish between that and luxurious vacations, extravagant jewelry, expensive clothes and pricey dinners.
Why are these credit scores important? It can make the difference between being able to obtain a loan and getting denied. Also, even if your score only drops a few points, it can result in higher interest rates. As far as lenders are concerned, lower credit scores equate higher chances of delinquency, which translates into a higher risk premium on your loans or flat denial of your application. Delinquency is defined as any default, bankruptcy, non-payment or 30-days past due payment. According to myFICO, the following are the delinquency rates for different categories of FICO scores:
800+ = 1%
750-799 = 2%
700-749 = 5%
650-699 = 15%
600-649 = 31%
550-599 = 51%
500-549 = 71%
0-499 = 87%
Assume for a moment that you are the lender. Armed with the “Delinquency Rate” chart, to who would you lend? The answer is obvious, the person with the higher credit score meaning lower probability of delinquency. The conclusion that more rehabbers are reaching is that using credit cards to fund projects can be a very bad idea. Credit scoring agencies cannot and will not look at your high credit card balances as revenue or income producing debt and you will be penalized. Therefore, rehabbers need to think about the consequences before succumbing to the temptation of teaser credit card offers.
In the case of rehab investors, taking the “Easy” route could be the end of your business and flexibility to borrow as a consumer. Rehabbers must adjust their thinking from consumer to investor if they intend to grow a profitable business successfully.
How To Properly Screen A Prospective Tenant
March 3rd, 2010. Published under Real Estate Investing. No Comments.
According to the the National Association of Realtors®, “distressed homes” represented nearly 2 of every fifth home sold in January 2010. Clearly, real estate investors in Chicago and around the country are taking advantage of good deals on cheap property. But there’s risk involved.
This NBC Today Show interview first ran in March 2009, featuring real estate expert Barbara Corcoran. Despite its age, the message remains relevant. Today may be a terrific time to buy a bank-owned home — just make sure you do your research first. There’s plenty of ways for investors to get burned.
Some of the tips in the video include:
- Buy in your own backyard
- Start small, then build to a bigger portfolio
- Watch receipts — rent rolls don’t matter if tenants aren’t paying rent
Corcoran also gives pointers on how to evaluate a prospective tenant.
Foreclosures should represent a large number of 2010′s total home sales and will offer interesting opportunities to bona fide real estate investors. Before you jump in, make sure to watch the video. The rents you save may be your own.
Remember, the stats and the data are from 12 months ago, but the advice stays meaningful.
