Credit, Lifestyle & Real Estate Investing

If you’re like most people, you probably have a vague notion that having good credit would be nice, and your father probably told you once that it was important, but you probably don’t think much about credit. When you do consider credit, you probably think of it briefly as something you should work on the way you work on a new year’s resolution, and then promptly forget it again.

To be fair, credit is an abstract concept, and it isn’t often that we’re directly confronted by it, so it’s understandable that most people don’t think it makes much of a difference in the way they live day to day. But it makes a huge difference, starting with the kind of house you live in, and ending with the type of school your children attend. If you’re a real estate investor, credit can make or break your career. That’s all rather dramatic, and still abstract, so we’ll make it a lot more concrete, using real numbers and calculations.

Tom and Veronica both live in the same city, and can both afford to pay around $1,200/month for their real estate payment. Tom has a bad credit score of 604, and Veronica has a good credit score of 752. They each have $11-12,000 saved for a down payment, and can save another $8,000 each year.

Veronica goes to her bank and speaks with a loan officer, who can fit her in a conforming loan program at 5.15% interest, with a down payment requirement of 5% of the purchase price, and no points required as an origination fee to the bank. Veronica calls up her real estate agent and starts looking for houses, and pretty soon she’s found a good one for $229,000, which will require a down payment of $11,450, which she has saved. Her mortgage loan will be for $217, 550, and at 5.15% interest that puts her monthly payment at $1,187.88 per month.

Tom has a harder time from the very start. First, he was turned away by his bank, whose lending guidelines require a minimum credit score of 620. After a few more calls, he finds a mortgage broker with a sub-prime loan program that will accept him, but the terms aren’t particularly friendly, because he’s such a high-risk borrower.

Tom is told that he will have to make a down payment of 20%, his interest rate will be an ugly 9%, and he’ll have to pay the lender two origination points as a loan fee (a point is equal to one percent of the loan). He will also have to pay private mortgage insurance, but that’s a story for another time.

At the terms of Tom’s loan, his $12,000 savings will only be enough for a down payment on a home costing $60,000. If he saves for another year, he’ll be able to afford a home costing $100,000; if he saves for two years, he’ll be able to afford a home costing $140,000. Tom can expect to buy a much lower-end piece of real estate than Veronica.

Tom saves for few more years, and buys a house for $159,000, and makes a down payment of $32,000, leaving him with a loan of $127,000. His mortgage payment will be $1,021.87, which leaves him a little room to pay his private mortgage insurance each month. At the table, he also has to pay the lender an origination fee of $2,540, to offset the lender’s risk in making a loan to someone like Tom.

Veronica bought a $229,000 house in an improving and appreciating neighborhood, several years before Tom was able to buy at all. The schools in her neighborhood are excellent, and her children get an excellent education. Tom’s children remained in the schools in the lower-end, mostly tenant-occupied neighborhood where he rented for several extra years, and when they moved, Tom’s children were upgraded to a better, but still mediocre, school system near Tom’s $159,000 house.

Their monthly payments are comparable, but while Tom had to scrimp and save every extra penny for several years to afford a down payment of $32,000, Veronica was able to put her extra savings each month into her retirement account, instead of a down payment. Veronica’s superior house will be paid off several years before Tom’s, and she’ll be able to retire several years earlier, because she was able to put that savings towards her retirement.

Imagine if Tom and Veronica were each professional real estate investors, whose careers hinged on their ability buy property quickly and efficiently, with minimal cash required. Who do you think would be more successful? Who would be able to negotiate more effectively with sellers, and leverage their buying power in their real estate investing?

Credit matters. Credit is the difference between a middle class lifestyle, and a working class or lower class lifestyle, and while you may not consider your credit on a daily basis, your credit affects your life in very real and very tangible ways, every day. If you’re a professional real estate investor, your credit affects not only your personal lifestyle, but your career success, and you just can’t go very far with bad credit if you’re interested in real estate investing.

Brian Gregory is a real estate investor who, at times in his life, has had nothing to bargain with except his good credit. He attributes his real estate investing success to his good credit, and in his spare time he contributes real estate investing articles to a variety of online resources, including EZ Landlord Forms, an online hub for landlords that provides state-specific real estate forms.