How Credit is Calculated, How to Analyze Tenant Credit, and How to Improve Your Own Credit Scores

If you’re a real estate investor, you’re probably familiar with the routine: you walk into a bank to borrow money, and the loan officer takes one look at …

If you’re a real estate investor, you’re probably familiar with the routine: you walk into a bank to borrow money, and the loan officer takes one look at your credit history and either saying “Sure, we can do the loan, you’ll need to put down five (or ten) percent,” or “Well, we might be able to do the loan, but you’d have to put twenty-five percent down at the table…” Simply put, real estate investors can’t afford to have bad credit, because credit means buying power, and buying power means everything when it comes to real estate investing.

Having worked in the credit industry for many years, I can assure you that you do NOT need “credit counseling” or “credit improvement services,” with the possible exception being if your credit report has erroneous data on it (credit counselors have a direct line to the bureaus to expedite the removal of erroneous data). What you do need, however, is to understand how credit is calculated, so that you can precisely and effectively raise your credit scores.

As touched on above, the first step any real estate investor should take to improve their credit is to pull a copy of their own credit report and review it carefully, to check for errors. If you find errors, call the bureaus directly to report them (it doesn’t take much longer than having a credit counselor do it for you, and you’ll save yourself a lot of money).

But how is credit calculated? Credit bureaus use a relatively small range of data to determine those all-powerful numbers, and only use a handful of criteria to arrive at your score. Some of these measures are obvious and universally understood, while others are widely misunderstood and cause credit penitents a great deal of confusion and wasted efforts.

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First, a measure everyone understands: late payments. Quite simply, any credit payment that you make more than thirty days late is a mark against you, and each mark weighs a lot. There are, however, only a few types of bills that report to credit bureaus, which will allow you to prioritize if you’re having a hard month financially: mortgage loans, auto loans, student loans, personal loans, and credit cards are generally the only loans that report to the bureaus. If you have a rental lease on a ski condo in Colorado, it’s extremely unlikely that your landlord will go through the trouble of reporting your late rental lease payment to the credit bureaus or any other tenant credit agency, so pay your mortgage and car loan before paying that rental lease, if you’re pinched one month.

Second, credit bureaus calculate the average age of your credit accounts, and hold it against you if all of your accounts are brand new. Rather, they like to see old, stable, credit accounts; a mortgage from fifteen years ago that you don’t run and refinance every other year, that same credit card you’ve had since you were eighteen, etc. Essentially, credit bureaus want to see stability, and they don’t want to see frantic efforts by you to find new credit and borrow money at every opportunity. Likewise, they don’t like to see your credit report being pulled every other day, as you go from bank to bank desperately looking for money. There’s a small, temporary hit to your credit each time you have it pulled in an attempt to borrow money, which doesn’t apply when you pull it yourself through the bureaus.

Another mark that can hurt your credit is the existence of public records that indicate that you owe money to someone and haven’t paid it. Judgments, tax liens, bankruptcies, evictions and the like are all brutally damaging to your credit report, so even though you can get away with being a little bit late on that rental lease without it showing up on your credit, if you let it go as far as eviction, it will show up, and it will hurt.  So, (drum roll please), make sure you pay your bills!

One last big one that most people misunderstand is that credit bureaus scrutinize the amount of your credit that you’re actually using. Basically, they like to see that you’re credit-worthy, and that banks and lenders find you trustworthy enough to extend a lot of credit to, but they want to see that you don’t abuse that credit, by charging up every card in your wallet. What they do is they take a ratio of the amount of credit you’ve charged up, over the amount of credit available to you, and ideally this number should be no more than a third.

When evaluating tenant credit reports, there are a few things in particular to analyze closely. As you’ve seen, scores can be deceiving, and you wouldn’t want to deny a good tenant just because they have a penchant for opening in-store credit cards. Look particularly closely at their late payment history, look for judgments, liens and bankruptcies, and look at their address history, to see how often they’ve moved around. Once you get the hang of viewing tenant credit data, you can predict with sharp accuracy whether a tenant is responsible about paying their bills and how long they’re likely to remain a tenant.

Successful, stable, responsible, middle- and upper-class people aren’t born being financially savvy, they’re raised that way. Having bad credit costs a lot of money and prevents a lot of opportunities, and the rich raise their children to protect their credit because it will open many doors and save them an incredible amount of money. Protect your credit, because it is the difference between owning a home or owning a piece of paper saying “rental lease;” it’s the difference between buying five investment properties each year or buying two; it’s the difference between being stable and wealthy and simply squeaking by.


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