You can find these claims all over late night television and the internet:
"You Can Become A Real Estate Investor with No Money and No Credit."
After hearing and seeing these ads, one would think that you can start buying real estate with no money out of pocket, that your credit never has to come into the picture and that three months from now, all of your financial problems are going to be over. It may sound crazy but that is exactly the attitude that many newbie investors come into this business with and it is the reason why most of them not only fail at this business, but also end up ruining their personal credit for years to come.
The fact of the matter is that investing in real estate is a business. To survive, you must treat it as such. Now what does it take to run a successful business? While there are many answers to that question depending upon the business that you are in, the one element that is required for any business is a good strong sense of financial responsibility. And what is the best indicator of your financial responsibility? The answer to that question is, of course, your personal credit.
As a businessman, mortgage lenders expect you to be more financially responsible than the average home buyer. This is why the credit requirements for investment property financing are considerably higher than those of a primary home borrower. You as a real estate investor are being held to a higher standard. An investor in today's market can expect to need to meet the following general credit requirements to get financing from a conventional lender: (keep in mind that these are general min. requirements and are not written in stone. Each lender will have its own credit and guide line requirements for financing.)
- Credit Score: a minimum 660 (a few lenders still offer programs down to a 620 score, but 660 is quickly becoming the new minimum credit score needed.)
- Credit Depth: a minimum of 3 open accounts on your credit report, in good standing and reporting for 24 months or longer
- Assets: 6 or more months PITI reserves plus funds to close.
- Employment: a stable 2 year job history (either in the same line of work or at the same company). If self employed, than you must be able to show 2 years self employment status before your income from that business can be used to qualify.
But what happens after you purchase the property? Do you have an exit plan? What if your initial exit plan doesn't work out? Do you have a back up plan?
Let's take a look at the following example to see how this can play out:
Joe is a first time investor. He has found what he believes is a good first deal for him. Now Joe has had some problems over the years. His credit is in bad shape and he has almost no money in savings, but after reading a couple of books and maybe a real estate investment study course, he feels that he has all the angles worked out and that his lack of money and credit aren't going to cause any problems. So Joe finds himself a private lender who doesn't check his credit and he buys first investment deal without a credit check and without bringing any money to the closing table. He is a little concerned about the 16% interest rate on his new loan, but he figures he'll be able to sell the house within 90 days anyway so he can handle the extra debt for a few months. So Joe rehabs his house and puts it on the market and waits. After 5 months, Joe still has not been able to sell his house and his loan is due for repayment at 6 months. Now Joe has a real problem. He can't refinance the property and turn it into a rental because he doesn't have the credit to get the permanent financing he would need and he certainly doesn't the tens of thousands of dollars needed to pay off his loan the following month. So what happens to Joe? Mostly one of couple of things, he'll either sell the property for what he has invested in it (and in doing so will make no money off the deal) or he'll be foreclosed on by the lender.
If Joe had cleaned up and taken care of his credit before getting into the business of investing in real estate, then he quite possibly could have done a cash out refinance and not gotten himself a much lower interest rate but also pulled some equity out of the investment property to help him out until he could sell it.
This scenario is one that happens all of the time in this business and it is a perfect example of why it is absolutely essential to clean up and maintain your good credit before you get into real estate investing. Trying to buy investment properties with no money and no credit leaves you with only one exit plan and that is to "fix 'n flip" the property. However to survive in the long term, you have to have a back-up plan; something you can do to get the property generating income if it doesn't sell quickly due to slow market, bad location, etc. And almost all of these back-up plans you can come up with require that you obtain some kind of permanent financing for the house. If your personal credit is bad, then you won't be able to obtain that permanent financing and your back up plans will all fly right out the window.
The bottom line is that the business of investing in real estate is not for everyone. If it was then many more people would do it and be successful at it. Don't get emotionally tied up by some advertisement telling you that you can get into this business without any problems. Only you know whether or not you have the financial responsibility to run and maintain a business. Only you know whether or not you already pay your bills on time and take care of your monthly debts like you should. And only you know if you are ready to make the life style changes you may need to make to become that kind of person. If you can't honestly and truthfully answer those three questions, than chances are good that you are not ready to become a real estate investor.
