What credit score do I need to buy an investment property?

Buying an investment property is a major step in becoming an active real estate investor. Purchasing a property in hopes of developing it in the future, flipping a single-family home like you see on TV for a profit, or buying an asset that generates passive rental income can all be exciting ways and reasons to invest in real estate.

There are, however, a lot of things you have to do in order to prepare and set yourself up for success. Naturally, you’ll need to do your research, work with the right real estate agent, and find a good deal. And once you do, you’re most likely going to want to finance the purchase, as opposed to paying all cash, which will involve getting a loan.

Typically, lenders that specialize in making investment property loans will look at the real estate, and check to make sure there is value there, that it is in good condition, and that it will appreciate. However, most lenders will also base their final decision on how well you, the borrower, are doing financially and how good your credit score is. This is why in this article, we’ll discuss what credit score you’ll need as a borrower in order to get approved to buy an investment property. We’ll also cover the rare exceptions where you can get a loan with a low score or no credit at all.

What is a credit score?

A credit score is a three-digit number that lenders use to determine how likely you are to repay a loan and repay it on time. Your credit score is actually the average of scores provided by three different credit bureaus: Equifax, TransUnion and Experian.

These companies setup complex algorithms that take into account a number of factors of your personal financial and payment history to calculate a number that best reflects your creditworthiness. Specifically, they’ll examine your current outstanding personal credit card debt, generated from credit cards, car loans, store credit cards, and the like. They track how often you pay on time, how much debt you have in relation to how much credit you were approved for by each different vendor or creditor. They monitor your credit for any signs of activity that are categorical behavior of credit unworthy borrowers, such as bankruptcy filings, and debt amounts recorded against your or sent to collections.

The ultimate scores these companies derive from your data and financial history range from 300 to 850 points which may differ depending on the bureau providing the data. An excellent credit score is considered anything above 750, whereas a good credit score ranges from 700 to 740, and a fair credit score hovers between 580 and 699. Commonly any score below 699 is considered poor credit, and anything below 580 classifies someone as having no credit whatsoever.

However, these days it’s close to impossible to have no credit. Everyone starts building a history as soon as they are old enough, usually around 16 years old, when they get their first summer job, get a college credit card, apply for any small loan or credit card, so it’s very rare for someone to have absolutely no credit, unless they are new to the country altogether.

Why your credit score even matters?

When buying an investment property you may be wondering why your credit score even matters. This is a natural question to ask because intuitively you would think that your personal credit history should not play a role in buying a property that you don’t even plan to live in.

Unfortunately, though, most lenders heavily weigh a potential borrowers’ personal financial and credit history before making a decision to lend. When considering whether or not to approve a real estate investor for a loan, no matter if the property that will be financed is a small duplex or a high rise residential tower, lenders like to see certain indicators that the proposed borrower will be actually able to afford the loan in a worst-case scenario.

In fact, the loan approval process for an investment property, highly reflects the loan approval process for a personal home. It involves lenders diving into a borrower’s income, their place of employment, their tax returns, their pay stubs, W-2 forms, bank statements, deposit activity, and of course their credit score. Credit plays an especially important role during this process because lenders reason that if a borrower has proven themselves to be creditworthy for personal debt items, then they are more likely to be creditworthy and pay back their loan on an investment that they’re making.

Put yourself in the shoes of a lender. Would you be willing to lend someone $5,000,000 to purchase a 60-unit apartment building, if that particular loan applicant has been struggling to make their $500 car payments on time and has a 600 credit score? Absolutely not. In the end, it comes down to making the best judgment as far as what the borrower can afford, and credit plays a huge role in that.

What credit score do I need to buy an investment property?

Now that you know what a credit score is and how it’s determined, let’s next look at what specific score you’ll need in order to purchase an investment property. Overall, most lenders across the board will like to see a credit score of at least 620 to approve a borrower. This, however, will vary greatly, depending mostly on the type of loan you would like to get for your investment property.

In general, there are three main types of investment property loans out there, each with its own credit score requirements.

Conforming Loans

The first are conforming loans. Here in the U.S. there are two goverment-sponsored enterprises, Fannie Mae (FNMA) and Freddie Mac, that provide insurance to residential mortgages for 1-4 units properties up to a certain dollar amount, so loand as the borrower meet their specific underwriting requirements. Because most lenders like to get the insurance that these enterprises provide, they will follow what is called the eligibility matrix, that Fannie Mae and Freddie Mac, or Fannie and Freddie as they are more colloquially referred to, outline, and in this matrix your can see the specific requirements borrowers must have for their down payment, cash reserves, debt to income, and credit score.

As a quick example, on a single-unit property, the necessary credit score might be as low as 640 if the borrower puts down 25% of the purchase price, has six months’ of savings to cover all property expenses, has a debt-to-income of 36% or less. However, for a borrower looking to put down only 15% for an investment property, who’s debt-to-income is closer to 45%, the matrix may require that person to have a minimum 700 credit score in order for them to be eligible for the loan.

Therefore, if you are looking to get a conforming loan that the lender is requiring meet the FNMA guidelines then assume you’ll need a good credit score of at least 640 to 750.

Jumbo Loans

The second type of investment property loan a borrower can get is a jumbo loan. Jumbo loans are common for properties that are 1-4 units in an amount greater than what the conforming loan limit is. For example, a borrower looking to purchase a $700,000 home as a rental property, in an area where the conforming loan limit is $620,000 would have to get a jumbo loan in order to finance and close on the dela.

Jumbo loans are considered nonconforming meaning they do not meet the standards set form by Fannie or Freddie, and therefore just by their dollar amount are ineligible for insurance by these entities. As such, the lenders that make jumbo loans, especially for investment properties tend to put into place even stricter underwriting standards and require even higher credit scores above 750 from prospective borrowers.

Asset-Based Loans

The third type of loan available to borrowers looking to purchase an investment property are called asset-based loans. Regardless of the loan amount or the property’s value, these loans are based more so on the viability of the property as an individual asset as opposed to the personal credit history of the client.

Lenders who make these types of loans, usually called private money or hard money lenders, will take into account a property’s condition, value in comparison to local properties, cash flow, location, demographics, zoning, and it’s potential for future use and increase in rental income as the basis of their determination to extend the loan or not. So if a borrower happens to find a really good investment deal, but has poor to no credit, they may still be eligible to get the funds.

For example, let’s say you strike a deal with an elderly woman to buy her four-unit apartment building, which she just remodeled, is fully occupied in one of the best areas in your town, and approach a lender for financing. So long as you still have the money for the down payment, closing costs, and loan fees, there is a good chance the lender will finance the deal and enable you to purchase the property even if you have a 500 credit score. This is because just by looking at the asset itself, they see it as a good investment.

The other reason asset-based lenders are more willing to lend you funds to buy an investment property even if you don’t have a good credit score, especially if its a really good deal, is because even if there comes a point where you are no longer able to make the payments, that means they will be able to recoup the property and either keep it for themselves or re-sell it at a higher price. This means even by lending to someone with poor to no credit, it can still be a win-win for the lender.

When you don’t need a credit score?

It’s important to mention here that there are also other certain scenarios where even if you don’t have sufficient credit, you can still get approved by a lender to buy an investment property.

Let’s say, for example, you are a self-employed business owner who has fully paid off your student loans, your car, and your home. You buy everything in cash and never take out debt and generate $1,000,000 a year in revenue, but write off most of it in order to avoid income taxes. Naturally, your credit score will be low because you don’t have any credit and you’re not making any debt payments. Certain lenders, especially those within that private money and hard money segment we discussed earlier, however, may still be willing to extend you a loan. The reason is that you have other sufficient proof of your ability to repay the mortgage should you be approved.

What if, however, you were this same business owner, but instead of having $1,000,000 in annual income you only had $100,000. There are still situations where you could get a loan to buy an investment property even if you didn’t have any credit, and this would be if you had sufficiently saved up enough money to cover the 20% down payment and closing costs. Across the board, lenders are willing to be flexible and work with buyers to close a deal if they have the cash on hand to invest into a property.

Additionally, even if you personally have poor credit, little to no income or savings, but still want to buy an investment property that you feel is a great asset that will pretty much cover its own debt, is to find an eligible co-signor on the loan. A co-signer is someone who can help you qualify for a loan using their own personal credit history, and agree to be held responsible for repayment of the loan and monthly mortgage payments in the event that you, the primary borrower, are unable to. Depending on the lender and their requirements, your co-signer can be a spouse, a friend, a parent or other relative that is willing to act in this capacity. And usually, they are able to co-sign for any type of loan no matter if it’s a conforming, jumbo or asset-based loan. Because you and your co-signer are getting the loan together, even if you don’t have credit, the credit of your co-signer can be used to your advantage to purchase the property.

So if you find yourself in a position where you have poor credit but have neither the funds or income to prove you can afford the loan, just know there is still hope for you to buy that investment property.

How to improve your score?

Fortunately, if after reading this article so far you feel your credit score is not where you would like to be in order to purchase an investment property, there are many things that you can do in order to improve and increase your score.

The easiest thing to do is to make sure you are always on time with all of your credit card and loan payments. Timely payments help build a positive history and score for you, so it’s critical not to miss a single payment for at least 7 years.

You’ll also want to make sure that you do not overutilize your credit. Usually, the best way to increase your score is to only use up to 30 to 40 percent of your approved loan limit, so if for example, your bank approves you for a $5,000 credit limit, reducing your balance for $1,500 will do wonders in lifting your credit.

Another tactic you can use to increase your credit score is to take out a personal loan and use the money to pay off any debts you have. This will help improve your score because it removes the balance from your credit report, but be careful here as this strategy is only for people who already make their payments on time and not if you are planning on simply paying late or missing them altogether.

There are also many other ways that can also positively impact one’s credit score such as: opening new lines of credit (although you’ll want to avoid store cards), taking advantage of cashback bonuses offered by certain banks; and transferring balances to low-interest accounts so you can pay them down more quickly.

Lastly, you’ll want to review any negative items listed on your credit report consistently, keeping an eye out for things like debt sent to collections, bankruptcies or judgments held against you. The last thing you want is to have something negatively affecting your sore that was put in your history accidentally or was reported completely wrong.

Don’t let credit stop you

If you’re really set on buying an investment property, don’t let the ‘credit score’ issue stop you. As we’ve indicated in this article there are many things you can do to either increase your score and become eligible for an investment property loan, or to circumvent the credit score requirement your lender imposes altogether. Ultimately real estate investing is something that should be accessible to everyone, which is why it’s my mission to make it possible for anyone. To get a custom evaluation of your credit and understand what your options are to purchase an investment property contact me here: telephone: 9177404325 and e-mail: info@aurumsharpe.com

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