Financing a Rental Property: Understanding the Credit Score

Last week I published an article about the different types of lenders you can work with to finance your first income property purchase. You can read that article here to learn the difference between A, B, and C lenders. If you’re aiming for a mortgage from an A lender, you will need a high credit score and a good financial background in order to qualify for this service. In today’s article, we’re going to discuss the credit score and all the factors that could be keeping yours below the satisfactory level.

What is a Credit Score?

Most simply put, a credit score is a numerical expression based on a level analysis of a person's credit files. This score is used to represent the creditworthiness of an individual. In other words, the level of your credit score is going to determine whether you can get a loan from an A lender or not.

As we’ve already discussed in the previous article, you will always have other options to finance your property even if your credit score is not good enough to get you a mortgage. You can look into B or C lenders or even consider a joint venture partnership where the other person brings forth the capital and the mortgage capability.

For now, we’ll focus on the main factors that influence your credit score. Here’s a brief overview of each of them: 

Payment history - 35% of credit score

Payment history is the most important factor influencing your credit score. Lenders want to see how likely you are to pay back the credit they are about to give you, and they figure it out by looking at how/whether or not you paid back your other loans and consumer credit.

Credit utilization - 30% of credit score

Credit utilization refers to the amount of credit that you are using relative to the amount that is allotted to you. For instance, if you have a credit card with a $10,000 credit limit, and you have a balance of $2,000 on that card, it is a 205 credit utilization. A widely-regarded rule of thumb is to keep your total credit utilization across all credit products lower than 30%.

Length of credit history - 15% of credit score

Creditors like to see that you have had credit history for a long time, and that you have used credit consistently. Those who have short credit history, or who have not regularly used the credit they were allotted, are seen as being at a greater risk of defaulting on their balances.

Soft and hard credit checks - 10% of credit score

A soft check occurs when you check your credit score, or when anyone else reviews your credit history for non-lending purposes. It does not negatively affect your credit score. A hard check, on the other hand, occurs every time you apply for a credit card or loan. Having too many hard checks in your credit history during a short period of time can negatively affect your credit score (knocking it 7-10 points). A large number of applications for credit products can signal financial difficulty to your creditors and make them suspect you of credit shopping.

Diversity of credit - 10% of credit score

Diversity of credit shows lenders how many types of credit products you have in your credit history. The more diverse your credit history - showing a variety of responsibly-used credit-used credit types like loans, credit cards and lines of credit - the better. Credit diversity with payments made on time shows lenders you are responsible with all types of credit, which makes them more apt to lend to you.

Check and Improve Your Credit Score

Naturally, it is in your best interest to improve your credit score and try to keep it as high as possible. A couple of ways you can increase your credit score is by paying your bills consistently on time, reducing your credit utilization, correcting and updating old information, keeping paid-off credit cards open for a while, and resisting credit inquiries unless you find it absolutely necessary.

For starters, check your credit score on Equifax to see your current credit score and start planning your next steps. Keep in mind that this is a soft check, so your score will not be penalized as it would if you did two hard checks within 6 months of each other.