Credit Score Case Study: An Aspiring Investor Tackles Debt, Month One

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This is the first post in a series chronicling James’s journey to improve his credit score.

“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.

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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.

good-credit

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.

credit-score

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.

Related: Why Boosting Your Credit Score to “Excellent” Can Make You a Better Investor

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.

credit-report

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.

About Author

Mindy Jensen

Mindy has flipped numerous homes in the past 10 years, one at a time and doing much of the work with her husband. She lives in Longmont, CO, and is always looking for an ugly duckling to turn into a swan.

24 Comments

  1. Terrence Arth

    Hi Mindy, it’s sometimes seem like high schools should be teaching a number of “life skills” to graduating seniors. I personally know of probably a dozen high school and even college grads that get a quick card, charged it up, found a new interest and decide they didn’t want to pay the balance or even just kind of forgot about it. It takes forever to get that score to the excellent zone and a simple misstep or two can drop the score like a rock. Then rebuilding the score is a long, tedious and most often a difficult dance of self denial trying to save money and pay off debt all while the “peeps” are off doing fun things and spending money. Teach your kids young to handle responsibility, practice saving and learning to appreciate a little self denial. The reward is worth it… as James is finding out.

    • Mindy Jensen

      Terrence, thank you for this.

      I totally agree! I remember being taught about how to write a check in school and compare prices at the grocery store. Nothing about applying or qualifying for a mortgage, nothing about budgeting, nothing about taxes.

      Not only should high schools be teaching this, but middle schools as well. And it should be mandatory, like English.

  2. Tim Puffer

    I have been working on cleaning up my credit as well. It helps a ton to lower your credit utilization. They will also look at how long you have had accounts open.

    I agree with Susan Goldthorp – Credit Karma is pretty awesome!

  3. Morgan Faulkner

    I used a program calls Section609.com. At the time I believe the purchase price was below $70.00. They give you pre-written letters, you just fill in the blanks. Follow the instruction and you can’t go wrong. I began seeing results within 60 day of writing my first letter.

    Good luck!!!

  4. Susan Maneck

    I accidentally found out how to give my son a decent credit score. When he was a teenager I added him to one of my credit cards as an additional user. Mine you, I didn’t give him, the credit card. I’m not that foolish. I kept it locked away unless I needed him to run an errand for me and then it went right back into the safe. When he was about ready to graduate from college, I checked his credit score and was amazed to find it was well over 700. He had inherited my credit history on that card. The only negative thing is that it also showed him owing 10K since that was the balance I had on the card. I quickly paid it off (something easily for me because I have tons of plastic.) My son’s credit score shot up to close to 800.
    There is also, of course, the issue of helping young people to understand how credit works. My son took out a student loan his freshman year of college, although it wasn’t really necessary. It was a Stafford Loan which accrues interest while in school. i was tempted to make those interest payments for him, but I decided against it because I wanted him to see what interest would do and at the time the interest rate on the loan was 8%. When my son realized how quickly the amount he owed was rising, he stopped taking out student loans, so by the time he graduated he owed only about 2K and thanks to the recession the interest rate had dropped to less than 3%. He paid that off within a couple of years. His first attempt to leave home proved to be a disaster however. He lost his job and started taking cash advances from his credit card to pay his bills. When finally he confessed to me that he made a mess of things, I tempted to pay off his debt, but instead I taught him how to rescue himself in those situations. Yes, he did move back home for awhile but I had him call the credit card company, explain that he lost his job and ask them to lower the interest rate. Naturally they froze the card but they lowered his interest rate to a more manageable 10%. He starting making money tutoring high school kids for the college entrance exam and did fairly well. He had never failed to make his minimum payments so his credit score did not suffer and he was able to pay off that credit card within a reasonable length of time. When he went to buy a new car last year, his credit score was 840. Pretty good for a guy still in his twenties. Did I mention he now owns two houses? He bought his first one for 23K and lived in it, but when he married he moved his bride to better part of town where he bought a house for 69K. The rent on the first house pays his mortgage on the second house. Actually, it pays the mortgage on both houses.

    • Mindy Jensen

      Thanks for sharing, Susan.

      This is an excellent way to give your child a leg up, without actually costing you anything. My parents did something similar for me and my sister when we graduated high school. They opened a new credit card/calling card (this was well before cell phones) and named us as co-signers or authorized users or something. We could use it however we wanted, but we had to pay it off at the end of the month, or they would take it away from us. I’m pretty sure I inherited their excellent credit scores.

      This is such an awesome idea. I think the child has to be a certain age before they are allowed to be added. I’m going to check into that. I’d love to give my kids a great credit score starting off.

  5. Shaun Reilly

    I found the article interesting and I will definitely read the subsequent ones to hear what happens to him.
    However it does seem like there is a little bit of the tail wagging the dog here.

    If he has less than $1K in CC debt and can’t just stroke a check to get rid of that he is not particularly close to home ownership and definitely not an investment property and credit score is not his #1 financial issue.

    Now not saying that getting up his score is a bad thing, or course it is good.
    It is also fortuitous that many of the things that will help his score will be good for his overall fiscal health (crazy how that can work out sometimes? 🙂 ) .
    Paying down the debt and bringing in some extra money from side work are exactly what he should be doing. It is just really more to pay off bad consumer debt, making sure his expenses stay within his means and hopefully build up some savings/reserves/emergency fund.

    The one move I would question is the secured credit card. First you usually hear that as a means for someone to build a score if they don’t have any credit yet or if they got ravaged so badly that all their credit accounts were closed. He still has 2 cards with one of them being a regular one.
    Seems like it would make more sense to just pay that off and then use it on a regular basis on purchases he can afford and pay off each month. It would be especially bad if putting the money with the bank to secure the card delays the debt payoff.

    Like I said interesting piece and I don’t think anything is bad for him.
    I just think that the plan should be to pay off crap debt and build a solid financial base, which an improved credit score will be a natural consequence of that, as opposed to the focus.

    • Mindy Jensen

      Shaun, this is a great point. He does have a fairly low balance to pay off, and this is not his only obstacle to starting to invest in real estate. And that is an interesting point with the secured card vs. the regular card. I know my own cards are always offering me higher limits, and his will most likely offer him a higher limit if he continues to make regular payments.
      I’m getting ready to write the next post, it should be out next week.

  6. Isaac Rothermel

    Thank you for writing this article. I’m 19 years old, and very interested in building a good credit score so that I can invest in real estate. I started building credit by taking out a bank cc in June of this year, and my current credit score is 681…does the score increase over time as you keep making payments every month? I haven’t missed any payments yet, but I had no credit score before I opened this card five months ago.

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