Credit Score Case Study: An Aspiring Investor Tackles Debt, Month One
This is the first post in a series chronicling James’s journey to improve his credit score.
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“I want to start investing in real estate, but I have poor credit.”
I see any number of variations of this statement pop up in the BiggerPockets Forums frequently.
Real estate has a certain allure. Get-rich-quick comes to mind, and there is no shortage of people willing to sell you on that idea. Real estate is really more of a get rich s-l-o-w-l-y sort of deal, but it certainly has the potential of making you wealthy—if you play your cards right.
Real estate is also expensive, as far as investments go. You can buy a share of stock for literally pennies in some cases. A house is going to cost more. Yes, you can get spectacular deals, especially in certain areas of the Midwest. But in most cases, you aren't going to have the cash sitting around to outright buy the house, especially if you are just getting started. So you'll need a loan.
What is a Good Credit Score?
My friend Todd Bukaty is a mortgage broker in Kansas City, meaning he qualifies people for loans according to Fannie standards and then sells the loan to another lender. He tells me that the best rates go to people with credit scores of 740 and higher. For every 20 points below that magic number, the rate increases, then jumps aggressively for scores below 680. A score of 620 is the lowest he will go, although he has seen other lending institutions that will go down to 580.
A BiggerPockets member contacted me recently, asking about investing with a low credit score. James (not his real name) has a fairly typical story—he discovered BiggerPockets and is in love with real estate, specifically the concept of “house hacking.” His low score is keeping him from getting a traditional loan.
I have read all about repairing your credit score, but I’ve never actually done it. I don’t know how long it takes or what works best. So here we are today, taking the first step to repairing James’s credit—and maybe yours, too.
Related: How to Improve Your Credit Score
Credit Report vs. Credit Score
Your credit score varies, sometimes quite a lot, depending on who is looking at the credit report and what you are trying to be approved for. Banks look at the report differently if you are applying for a mortgage than if you are applying for a car loan. Same with credit cards.
Your credit report is the information that is used to create your credit score. Your credit score is a number based on the risk level you present to creditors.
Credit scores range from a low of 300 to a high of 850. The median credit score in America is around 692. (There are several ways to determine credit score, but the most common score uses the FICO system, and that is what we will be using and referring to during the course of this series.)
The Main Cause of James’s Low Credit Score
So let’s get back to James. James has a credit score lower than the median. He is in his early 20s and doesn’t have a long credit history. What he does have has been blemished by a miscommunication. He thought a family member was going to make a payment on his credit card on his behalf as a gift. When that didn’t happen, more miscommunication led to his credit card being delinquent for 6-7 months.
The card was issued through his bank, and the balance appeared on his monthly statement, then suddenly disappeared around the same time that he thought the gift payment was made, so he didn’t question it.
It remained off his monthly statement for 5 months or so, then suddenly appeared again, with fees, interest, and late charges almost doubling the total. Then they called him to discuss the outstanding balance.
He negotiated a payoff of about 2/3 the total amount, which was higher than the original balance of the card, but obviously less than the new balance with all the fees.
Credit Reports: Get All Three or One Every Four Months?
On my suggestion, James went to AnnualCreditReport.com and got a copy of his Equifax credit report. There are three main credit reporting bureaus, and each is required by law to give you one free copy of your credit report every 12 months. But you don’t have to get them all at once, and many people choose to get them every few months as a free way to “monitor” their credit.
While there are three reporting agencies—and every so often one will have a report that another does not—they do basically have the same information. So for the purposes of this series and to monitor James’s credit report for free, we are only getting one report every four months.
The Current State of James’s Credit
Currently, James has two credit cards open, no car loan, and no mortgage. One card is a major credit card, and the other is a store card he opened up to save 30% off his purchase. This card has a zero balance.
His major credit card has a limit of $1,000, and his outstanding balance on the card is $910, which shows a 91% utilization rate. This affects your credit score as well.
The card fiasco mentioned above has not sorted itself out on his credit report, which is affecting his current score. The card shows up as a 100% charge-off, which means the issuing bank wrote it off as uncollectible bad debt. Since he paid a majority portion of the balance, including all that he originally owed, his score should improve once this all shakes out.
Method #1: Secured Credit Card
This month, James is going to get a secured credit card. This is a major credit card issued through a bank. The physical card looks just like any other credit card. The difference is that rather than the bank extending you $XX in credit, you give the bank a deposit, typically $200–$2,000. This deposit amount becomes your credit limit.
You use it just like a regular card, and they send you a bill, just like a regular card. When you make the payments on time, they report this to the credit bureaus just like a regular card. The only difference is the deposit, which is used to cover the charges if you don’t make any payments.
But not everyone qualifies for even a secured card. Recent bankruptcies, open collection accounts, or current delinquencies can get you denied. Banks don’t make a lot of money on secured cards, so they aren’t going to stick their necks out for a few pennies. They offer secured cards in the hopes that someone who turns their credit around will sign up for a traditional card, which is a revenue generating business for them.
Method #2: Pay Down Current Debt
James is also going to focus on paying down his current debt. A 91% credit utilization rate on his card is too high. James is going to aim to pay down his balance so his total utilization isn’t above 30%. For a young guy just starting out, this may take a couple of months.
I’ve recommended that James find a side job—something he can do for extra money when he isn’t working his normal 9-5. He has a lead; we’ll see how that goes when we check in next month.
Starting Credit Score: 617
I’m actually surprised at this number. When James contacted me, I was prepared for this to be much lower. I was listening to the Clark Howard Show on the radio recently, and a man called in to talk to Clark about how to improve his score. When Clark asked him what his score was, he replied, “I’m not sure exactly. It’s in the high 300s or low 400s.” As Clark told the caller, this is just about as low as you can go.
So James doesn’t have an insurmountable problem. Next month, we’ll see how much he was able to pay down on his current card, see if he was approved for a secured card, and talk about another way to improve his credit score.
Have you had to repair your credit, or do you have an innovative way to boost a score?
Please share what has worked for you.