Question: I recently acquired a rental home in addition to my primary residence. I am now in the middle of acquiring another rental. I noticed my Experian score dropped 13 points when the real estate debt showed up on my credit report. Even though the rental generates income, my score takes a hit. How do the lenders view this? Do they consider a healthy bureau report (no negative info) with a point drop due to real estate acquisition as a positive or negative?
Answer: Your credit score is a fluid number. It’s not like a grade given to you at graduation that follows you the rest of your life. Today, your score could be 750. Next year it could edge up to 760 and later turn down to 695. There are variables that determine your score on any given day depending on what’s happening in your credit life at the moment.
Experian’s Web site explains: “Scores used by individual lenders may use such elements as income, occupation and type of residence in determining their own custom credit score.” As your debt level increases and decreases, you will experience fluctuations in your score, as well. However, debt level is only one of the factors that determine your score.
As an investor, trying to acquire property after property will eventually beat up on your score if you’re not careful. This is why you’ll see a lot of investor courses out there talking about zero down, owner financing.
The reason an owner may be interested in financing the sale of a property is two fold: a) he or she will benefit from all the equity that has built up on the house over the years; and b) now that equity is turned into a note and they are receiving a guaranteed interest return.
Just to digress a moment, let’s look at a sample of such a scenario. If an investor purchased a property for $50,000 and 15 years later it sells for $150,000, that’s a 200 percent gain on the value of the property. The property has already created a lot of cash flow over the years through rental payments, but now he sells and holds the loan for $150,000 (if it’s zero-down financing). With a no-downpayment option, the investor is obviously going to charge a higher interest rate than what the traditional money market demands — say 2 percentage points more.
A $150,000 mortgage at 8 percent today will result in a mortgage payment of $1,100.65. If the investor had originally financed the property 15 years earlier at 6 percent, his payment on $50,000 would have been $299.78 — a spread of $801.87 per month if he holds onto the old note — that’s more than $9,000 per year in income from the property.
The investor holding the note now has a couple options — hold onto the note for a passive cash flow over the next several years or sell it at a discount and take his cash and run.
This is obviously not traditional financing. When an investor goes through traditional channels to obtain financing for purchases, those banks and lenders are going to report the investor’s debt load to the credit reporting agencies. As your debt load increases, it will affect your credit score — even if the properties being held are creating a cash flow. You may have a cash flow, but the reality still remains that the house maintains a mortgage from Bank A or B. Those mortgage amounts will affect your credit score.
When you use owner financing, as described above, most likely a private owner is not going to report to anyone, except maybe the courthouse, that you have a loan from them. It’s a personal deal between the investor and the note holder who is probably an investor just like the purchaser. Technically, an investor could hold millions of dollars in mortgages on investor properties from personal note holders and it never show up on his credit report. It just depends on whether the notes are recorded with the agencies. At settlement, the attorneys or escrow agents will report any income from the transaction to the IRS.
Most investors are at least going to record the note at the courthouse to protect their interests and give them the legal hold on the property needed to foreclose if the new owner defaults.
As far as your cash flow is concerned, this will be looked on as income, but the loan officer may also write in a vacancy factor. Most likely, you will experience periods of vacancy and the loan officer will compensate for that against the cash flow.