How Upcoming Credit Scoring Changes Could Affect Real Estate Investors

by | BiggerPockets.com

Think credit doesn’t affect your day-to-day life?

Think again.

A real estate investor with excellent credit can secure a mortgage for as low as 5-6% in today’s market. Another investor with terrible credit could pay 12-15% for the same loan, except they probably wouldn’t be offered the same loan; they would likely need to come up with a much larger cash down payment.

But change is coming to the credit reporting industry. Starting in July, the three major credit bureaus—Equifax, Experian, and TransUnion—are changing their algorithm for how credit scores are calculated.

How will credit scoring change? More importantly, what does it mean for consumers and investors?

Judgments & Tax Liens to Magically Disappear

The credit bureaus will no longer include most judgments and tax liens if they don’t include the consumer’s full name, current address, and either their Social Security Number or date of birth.

What portion of judgments and liens currently don’t include all of that data? Most of them, apparently.

Sarah Davies, Senior Vice President of Product Management and Analytics at VantageScore, explains that “almost all civil judgments will be removed from credit files, and a substantial portion of tax liens will be removed from credit files.”

Nor does the data purge end there. Information on judgments and liens will also need to have been updated within the last 90 days. Otherwise, you got it—excluded from the reports.

That means that 12 million people will see an artificial jump in their score this summer. But that kind of score manipulation and data loss come with a price tag—more on that later.

private-money-meeting

Related: Credit Score Too Low? Rescoring Could Help You Get the Loan [With Real-Life Example!]

Medical Collections

In a similar move, the bureaus will limit medical collections in credit reports moving forward.

Medical collection data will only become eligible after a six-month waiting period since there is so often confusion over who is responsible for paying them. Medical billing tends to lag and often creates enormous confusion over whether the consumer or insurer is responsible for paying a given bill.

And let’s be honest, consumers often have to dispute insurance companies’ attempts to deny reimbursements and coverage.

Trend Data & Machine Learning

The credit bureaus seem to be losing a lot of data here, which means scores with less predictive power. So how are they offsetting these losses in accuracy?

In a word, the bureaus are regaining lost ground with better data analytics.

Historically, the credit bureaus have simply taken a snapshot in time of a consumer’s data and history. With these changes, however, they are starting to look at how the consumer’s behavior has trended over the last six months. Have they shifted toward paying more bills on time? Or are their payments getting later and more sporadic? Are they paying down their credit card balances or racking up more debt with each month?

The bureaus expect their better trend analysis to improve how predictive credit scores are by over 20% for people with good credit.

But what about people with bad credit? Therein lies the rub.

Why We Can’t Just Legislate Bad Credit Away

Waving a magic wand and making someone’s judgments and liens disappear doesn’t suddenly make them a good borrower. It just means that scores are less accurate for people with previously poor credit.

Lenders price their loans based on risk. They can afford to give someone with perfect credit a very, very cheap loan, because they can accurately project an extremely low default rate. Likewise, someone with poor credit is much more likely to default, so lenders price their loans higher to account for the higher risk.

Less predictive scores mean less precise pricing, which means higher prices for anyone whose credit reports leave room for doubt.

LexisNexis Risk Solutions found that people with liens and judgments are twice as likely to default on loan payments. Those risks don’t disappear just because credit agencies change their algorithm, and lenders aren’t just going to roll over and swallow the extra risk. They’ll change their pricing accordingly.

That means higher pricing for many borrowers who previously have gotten a better deal. In other words, with more low-credit borrowers looking like mid-credit borrowers, expect higher pricing for all mid-credit borrowers. Classic subsidization.

Answer me this, while you’re at it: What is the incentive for people to pay old debts if they won’t appear on credit reports?

And what about landlords, who rely on credit reports to screen renters? Judgment data is especially significant for landlords trying to separate responsible renters from those with unpaid debts (including unpaid rent judgments from evictions).

What’s Behind These Changes, if Not Predictive Accuracy?

You already know the answer: politics.

It started in 2012 when Congress ordered a report by the Federal Trade Commission to examine credit reporting accuracy. That report found that one in five consumers had at least one error on a report with at least one credit bureau. The FTC has continually turned up the heat on the bureaus ever since.

Related: 3 Simple Steps to Significantly Raise Your Credit Score Within 12 Months

Nor is it only the FTC. A series of lawsuits brought by state governments against the bureaus ended with settlements being reached with 31 state attorney generals. As part of the settlement, the bureaus had to remove data from their algorithm, including whether consumers paid personal bills such as gym memberships and traffic tickets.

And to bring it full circle, it was the Consumer Financial Protection Bureau that ordered the credit bureaus to remove judgment and lien data from their algorithm.

What, you thought the bureaus would intentionally leave out legitimate, predictive data? Forget about it. Predictive accuracy is the measure of success in the credit rating world. But politicians have intervened to make high-risk borrowers look artificially more credit-worthy in an attempt to make more money available for low-end consumers without having to cough it up themselves.

What It Means for Maximizing Your Score

So how do these changes affect your strategy if you’re looking for the most efficient way to improve your credit?

First, you may be off the hook, credit report-wise, for old judgments and tax liens. Regardless of its implications for credit markets as a whole, on the individual level, it means these old debts become much lower priority.

Second, it’s worth noting that the most recent version of FICO and the upcoming VantageScore updates both ignore old collection accounts that are paid off. In other words, paying them off doesn’t improve your credit score. So once again, they become lower priority bills.

Third, momentum matters. Start working on paying down your revolving debt (i.e. credit card debt) and keep paying it down every month. This is good financial sense anyway since credit card debt tends to be the most expensive debt. But even if you can only make the minimum payment one month, it’s much better than missing a payment. Build a track record of on-time payments.

Fourth, always, always pay your mortgage on time. Every month, no exceptions! Mortgage payments are now weighted heavier than other types of debts.

Lastly, when you have a medical bill due, put a note on your calendar for six months after it was first due. That’s your payment window—make sure it’s paid (whether by you or your insurance company) within that six-month window.

Better Credit Literally Means Twice as Many Deals

Better credit means smaller down payments, lower interest rates, lower monthly expenses. Get yours above 700—and preferably above 750.

Responsible Renee has a gleaming 790 credit score. Her local community bank lends to her at 6% and one point for her investment properties, at 80% LTV. For a $200,000 property with a 30-year loan, that means she puts down $40,000, pays a $2,000 loan fee, and has a monthly payment of $959.28.

Scatterbrained Steve has a sloppy 575 credit score. He’s lucky if hard money lenders will lend to him at 60% LTV. He pays 12% interest and four points. For that same $200,000 deal, his 30-year loan requires $80,000 as a down payment, an $8,000 loan fee, and a monthly payment of $1,234.34 (for a much smaller loan of $120,000).

Renee can afford to do twice as many deals as Steve. In five years, her portfolio will be twice as large and will have quadruple the cash flow because her expenses are so much lower.

Credit matters.

What do you think about the upcoming changes? Should borrowers with good credit be subsidizing those with bad credit? How far should the government go to regulate credit scoring?

Let’s discuss below!

About Author

Brian Davis

Brian is a rental investor with 15 income properties, who provides free video training to help everyday people start earning passive income at SnapLandlord.com. He's also the co-founder of SparkRental.com, which provides free services & education for landlords. His rental management is almost completely automated by now, allowing him to travel the world (his current home base: Abu Dhabi).

19 Comments

  1. This is a disaster for landlords trying to collect judgments from renters and landlords that are screening out tenants based on things like judgements, liens, and what not. Landlords do not have the same capital as Chase and Citibank and this will result in more deadbeat tenants. Chase can afford a few more writeoffs. I cannot.

    Many landlords I know pursue a judgement along with an eviction. Most of the time, the judgement never gets paid. However, if a renter decides they want to purchase a home or a car, the lender will make them clean up old judgements. Maybe settle for 30 or 40 cents on the dollar, but at least the landlord receives something. This arbitrary law just lets scofflaw renters completely skip out.

    Get your security deposits up! Start eviction after 5 days ( or whatever your county allows)

    This is really bad, but of course no one in DC cares about landlords. And they wonder why there is an affordable housing shortage!

  2. Kevin Griffin

    Just another example of the government subsidizing low income people in order to make it easier for them to get loans they have no business getting in the first place. Can you say 2008 all over again? Less than a decade since we almost went under from the subprime loan debacle, and here we are again, headed towards the same disaster. The answer? Let the lenders do these subprime loans on their own dime, with the resulting consequences applied to them directly, without government intervention in any way. In other words, no lender is too big to fail. President Trump’s return to lackadaisical lending standards is going to hurt this country in a big way, when we go through another round of banks closing, and the government having to prop up the big boys, so they have a much smaller mess to mop up. Do you think that if all lenders were held responsible for their own subprime loan defaults, they would be lending in such an irresponsible manner?

    • Brian Davis

      Yeah politicians smell an easy win, trying to just legislate their way to everyone in America having good credit and easy access to money. But they clearly haven’t learned the lessons of the (not-so-distant) past, where not everyone should have easy access to credit, because they can’t or won’t repay it. Ugly.

      • chris gibbs

        Your credit worthiness is based on past debts paid. If you never have any debt then how are they supposed to know if you are good at paying it? For your next car or purchase try getting a short term loan that you keep for at least a year. Set it up on automatic payment and forget about it. That will give you some credit history to work off of.

    • tim boehm

      Right on Kevin! Now hear this, my wife and I are worth 2.2 million. Our investments are about 1/2 realestate and the rest cash in the bank and a few stocks. By the way the interest on a million in the bank today won’t pay your light bill. No one gave us anything, we simply worked and saved, the only loans we ever had were from the seller when we were buying property, no car payments, no credit cards, we always paid our bills on time, never but once left a debt ($100 and I should have sued the ass that company but we don’t believe in that). And yet I have a low credit score. So there has always been a bias toward good and responsible people like us, now as you say the dead beats and scammers of the country get another break yet we can’t catch one. Oh it really doesn’t matter much now as we are both 65, but the injustice still stings!

  3. Paul Merriwether

    NOT A BIG DEAL!!!! Many people learn over time to manage credit better. Banks need people to borrow in order to stay in business. Those people that fail to pay on time will again have poor credit. There is a reason banks make so much money, they know people’s habits!!!

    I get daily offers to borrow either from a credit card with 0% interest as far in to the future as Nov 2018 by paying only the initial 3% fee on the money borrowed. Lending and taking on RISK is what keeps banks in business, they love bad borrowers!!! That is how they make their money!!! It isn’t from good borrowers!!! They love people like Tim Boehm, the previous poster. He pays on time and never really had high scores. The fear of being in debt cost them in terms of wealth. Even though Tim has done well over time … his wealth could have been greater if he had learned to use credit to his advantage. Yet he blames the system!!!

    Me … I’ve been on both sides of the fence in terms of good & bad credit over time. It’s better to have good credit & options than poor credit and virtually no options.

    • Brian Davis

      And will cost twice as much, for data that should be included in a credit report. But I imagine that collection agencies and debt specialist law firms will adapt, and start making sure their judgments include the required data.

  4. JL Hut

    Many of you will scoff at this, and dismiss it, but you may remember what I said years after I am gone. Here is my thoughts on credit and the “BiggerPicture”

    Years ago I used to do my own title searches on homes I was interested in. For fun I would go back into the 1800s to see what life was like then. In the 1800s and early 1900s it was uncommon to have a mortgage on your home and if you did, it was for 8 months to have money to buy seed for your farm to raise your food for the year and pay it off in the fall at harvest time. My, how things have changed.

    How did we go from being content to live on what we earned to now borrowing tomorrow’s wages to spend today on mostly worthless deprecating junk with little value? We love it so much we will voluntarily pay a bank 5% to 25% or more for the privilege to do it.

    Because most of you grew up with this being the norm, you don’t question it. But you all should step back and ask yourself, why do we do this? Is it sustainable? What if the government did the same with no plan for repayment or change? What if the government borrowed $$ from foreign powers, even adversaries?

    Just like some of the most successful of you in RE, you take time out to look back over your RE history and try to learn from your mistakes. Let’s take that a step further and look at the bigger history, say the last 3000 years. There is much to learn, and we need to ask many questions. One we could ask is: What has happened to other great empires when their people and government got distracted with trying to make themselves feel better today and not governing and sacrificing today for a better future? Well, there are many examples but let’s look at one that seems to be a good fit.

    The Roman empire is a great example, one the the most organized governments in the early days, great military strength and intelligent, innovative people with the latest technology. Sound familiar?

    In the end it was every man for himself, seeking his own pleasure any way he could without regard for the future of Rome or fellow man. No one at the time would ever believe it would end, not the great Roman empire.

    Your most likely response is that you will find ways that we are different than Rome. But one thing RE has taught me above all else is that people seldom change, most are stuck in repetitive patterns. The same ones from yesterday, one hundred or one thousand years ago.

    Sure you think you are unique and different, but are you really that different? Your wife can predict how you will react when someone cuts you off in traffic. Credit reporting agencies can divide you into subgroups and predict what you will likely do in the future.

    I contend that past history of groups of people will predict where this group (USA) will end up in time unless we learn to say no to today’s pleasures for a better tomorrow. Both individually and as governors of our society.

    One of the wisest men of the past, recorded in a book over a thousand years old said this after seeking wisdom his whole life. “There is nothing new under the sun.” Indeed there isn’t, for man keeps repeating the same patterns.

    For now I am diversifying some assets away from RE into things that don’t decay but glint in the sun, just in case something happens in my lifetime.

    I know you think I am crazy and I may look that way for decades, but ask my heirs how it worked out.

    Feel free to disagree with me, tell me what you think, but support your reasons. I want to know the “why” you think what you think.

    • Paul Merriwether

      How funny you think gold is the way to go. What does Warren Buffett think about gold??? Not much!!! He views it as a shiny lump. It doesn’t do anything for you … it’s just there. He said he’d rather own a farm that produces & adds value over time.

      In terms of the Roman Empire … Rome is still here just as are many of the artifacts they created right down to their shiny gold pieces!!! Not even the Romans could stop Christianity!!! CHANGE always comes!!!

  5. Vic Stezin

    The only thing the government does well is break things and kill anything with life…….. So now that they have their fingers in this it will only lead to loss for everyone. Lenders have always known that governments involvement increases their risk and they will make adjustments to their criteria for lending that will cost most borrowers more.

    This means you must guard your score by watching it even more closely because the top tier will now occur at a higher score. As usual the cost for the collectivist ideology of our government is that the responsible must pull an even greater share of the burden.

  6. Mary B.

    great blog, Brian. very insightful for financial situations all around. whether one is new or seasoned investor, looking to move, start a new job, returning to college(oh wow, what about that insane debt? ouch!). this is terrific need to know for any life adjustment big or small because it always effects the budget. thanks a million. I’m definitely sharing this a few times. all the best.

    Kudos,
    Mary

  7. I take issue with the fundamental assumption in the introduction to the article. You are assuming that simply more information provides increase predictability in the outcome. That is not true. The proper information with the proves correlation to the wanted outcome is the data that should be evaluated. As part of my W-2 job, I do estimates for costing and schedule and more data just drives up cost if it’s not correlated to the outcome. There are likey other data available that would increase the likelihood of accurate prediction, but it needs to be researched to identify it.

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