Why Credit Scores Matter & How to Improve Them

by | BiggerPockets.com

Credit scores are powerful indicators of creditworthiness and the likelihood of default, especially when applying for mortgages, credit cards, and auto loans, or when renting real estate and buying insurance. Your score can dramatically affect the cost of credit, because the price and terms you receive are (fortunately or unfortunately) based on this score.

The bad news is that very few of us are taught the discipline of how to use credit correctly.

One of my very best friends, who I met in construction years ago, told me one of the wildest stories about the extremes of credit. My buddy came from Iran, a country that doesn’t have the same type of credit or mortgage systems that we have in the United States. He says that traditionally, most things in Iran are purchased with cash.

My buddy was part of the Shah of Iran’s elite guard when suddenly the regime changed. He was imprisoned and tortured by the Ayatollah’s government. He finally fled to Germany, where he met his future wife, a U.S. citizen. They eventually moved to the States, but a few years later they went through a difficult divorce that forced him into personal bankruptcy.

Since he was my friend, I wanted to help him get back on his feet, especially since his biggest dream (besides becoming a U.S. citizen, which he did) was to buy a home.

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

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Act I: Easy Come, Easy Go

At first, my friend didn’t understand our credit system. After he arrived in America, he couldn’t believe how easy it was to get money from banks and credit card companies. He and his ex-wife were quick to run up lots of debt, not understanding that  borrowing can become.

Act II: New Habits

Since he was a friend, I agreed to help him recover from these mistakes, but I insisted that he do everything I said. He agreed. We then proceeded to fix the damage.

Coming off a bankruptcy is about as tough as it gets, next to having a foreclosure, IRS lien, or student loan default; but one thing I know is that time heals all wounds.

In the beginning, I asked him what his system was for paying his bills. He confessed to me that he really didn’t have one. Instead, he paid whomever was screaming loudest.

I explained to him that he needed a system to follow. To get started, I had him bring all of his bills to me. Everything. I wanted to see all expenses, debts, and income.

First, we went through his expenses to see which ones made sense and which didn’t (needs vs. wants). Next, we looked at his debts, and then we categorized them. Some would report to credit, and some wouldn’t. Some could be paid off over time with a payment plan. And, some necessities needed to be paid faithfully and on time.

Of course, we looked at income as well. Since his job was seasonal, we came up with a strategy for income fluctuations, as well as a strategy to pay his bills on time. We also figured out a plan of attack for dealing with his outstanding debt.

It wasn’t long before he even got a secured credit card in place and stopped getting reported for delinquent accounts. As time went on, the negatives on his credit report began to be replaced by positives.

Act III: Building Credit

There are companies out there that can perform credit repair magic. Some may work, and others may be more questionable (for a fee of course).

But the one thing that works every time is paying your bills on time.

I told my buddy that my system entailed filing my bills as they came in by due date. Then on Sunday nights, I’d pay all the upcoming bills for the next week. (Today, of course, I use automatic payments for about 90 percent or more of my bills.) If there were outstanding bills he couldn’t pay in full, he sent partial payments, especially to ones that were fixed, like past medical bills.

Three Years Later…

Now, for the good news. In less than three years, my buddy bought his first owner-occupied house, which had a mortgage payment that was less than his rent. Shortly thereafter, he started purchasing 2-3-bedroom rental properties. Sure, he had to pay a slightly higher interest rate, but he had achieved his dream and still, cash flowed from his two rentals — all after coming out of bankruptcy.

The good news is, if he can do it, so can you.

Related: 7 Novel Ways to Use Credit Cards for Real Estate Investing

Knowing When to Protect your Credit

Are there times credit doesn’t matter? Absolutely.

Sometimes you’ll see senior citizens paying in order to protect their credit, and they don’t even need credit anymore. I saw this recently with a close family member of mine.

There are situations where a family should stop paying a debt because their situation is dire, and it’s no longer wise to do so.

But, if you have good credit, and you plan to need it for a while, it is prudent to be vigilant in protecting it. I know I am. Here are few ways that paying more attention can help your credit:

Pay Attention!

Have your bank alert you of unauthorized use of your credit cards. Check your bills, bank statements, and accounts regularly. Review your budget, income, and expenses periodically.

Also, be pragmatic. Know which bills report to credit and which ones do not. For example, many utilities don’t report to credit (but some do). My cell phone bill does, but my water bill doesn’t; if you have to be late on something, your cell phone is probably one of the worst bills to be late on.

Last, be strategic about your credit. Limit the size of the credit cards in your wallet in case you’re robbed. Keep your identity as safe as possible. Check your credit report yearly. Even I had to have errors corrected. Be careful opening and closing credit accounts, and be aware of the effect doing so will have on your score. And lastly, be aware of your debt-to-income ratio.

The only other way to protect yourself (beyond what’s listed here) is to own less and control more. This has been my number one strategy as of late.

That said, I know I don’t have all the answers. I’m sure there are many more strategies out there. Please share your favorite.

What have you done to improve and protect your credit score?

About Author

Dave Van Horn

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for over 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

10 Comments

  1. Cindy Larsen

    Credit cards are like fire: used carefully, they can keep you warm, and enable you in every financial area if your life. Used carelessly they can burn up everything you own. Here are some rules I’ve learned to get my credit score up, and keep it up:

    If you have credit card debt:
    1. STOP buying on credit, and pay down your debt. Credit card debt carries high interest rates which can ruin your finances. Stratagies:
    A: Transfer your highest interest balances to new credit cards with offers for zero interest for six months. Keep making at least the minimum payment from your old card onto that same debt on the new card. If the debt is not gone in six months, transfer it again. The interest rate on these cards doesn’t matter because, you are NOT going to buy anything with these new cards. They are simply a way to pay of your debt quicker, by not paying interest on your debt, so all of your payment goes to principal
    B. Use your savings or take out a HELOC and pay off your debt. A HELOC at 4% or whatever is a lot less expensive than owing the credit card company that amount of principal at 18% or 24%
    C. Make on every card, AND pay as much as you can on the highest interest rate card

    If you don’t have credit card debt: get some! BUT Don’t go into debt. NEVER buy anything with your credit cards that you do not have the money to pay cash for. BUy it with credit, then immediately pay off the debt with. This requires discipline, but has great rewards. Having and using credit cards will improve your credit rating within a year or two. Cashback credit cards combined with autopayment in full will earn you tax free money.
    Here is how to do it:
    1. Get cash back cards: look on creditkarma.com for recommendations of cards you are likely to be approved for. The interest rate is irrelevant, because you are NOT going to be paying interest. Get cards with no yearly fees.
    2. Use your credit cards to buy everything you can: autopay your bills, buy groceries, gas, etc. All the things you HAVE to pay for in the normal course of living.
    3. Setup “autopayment in full each month” on every one of your credit cards
    4. If you use a credit card to buy something that is not in your budget, buy it with the card, then go online immediately and make an extra payment for the full amount of the extra expense.

    The cash back cards will give you a credit on your account that is real money, extra income for paying your bills, that you can apply directly againsnyournoutstanding balance on that card THe IRS sees this cashback reward as a discount, so you don’t have to report it on your taxes (disclaimer: I am not a financial advisor or a CPA! Check this info for yourself)

    Example: you use cashback credit cards with an average cashback percentage of 2% to pay $1000 worth of expenses each month. This gives you a cashback reward of $20/month or $240/year, which you use to pay down the balance of your credit card. Yes, it is a small amout of money, but at the same time you are doing this your credit score is increasing. And paying your bills is automated.

    My favorite cards:
    1. American Express blue cash card: 6% back on groceries at any storemthat registers as a grocery store with the credit card companies: Safeway, whole foods, etc, but NOT Trader Joes or Costco
    2. Citi Doublecash Mastercard: 2% on anything, anywhere you use it.
    3. Costco Anywhere Visa: 4% back on gas, 2% on anything at costco, 3% on restrauant and travel

    I hope this helps.
    CJ

    • Dave Van Horn

      Hi Faith,

      People do it. It depends on the variation of the credit line. Is it secured or unsecured? Is it tied to the business? Did you personally sign? How are your financials of the LLC? (if your LLC isn’t doing well, they could call the loan)

      But no matter what, there’s still likely to be expensive cash advance fees and/or an expensive rate. So why not just use private money?

      Best,
      Dave

  2. David Hodgson

    WE WOULD LOVE TO BE ABLE TO SEE AND HEAR YOUR WEBINAR BUT WE ARE NOT GOING TO BE ABLE TO DO SO ON THIS DATE OF SEPT 20TH 2017 AT 9:00 AM IS THERE ANY OTHER TIME AND WAY TO HEAR THIS PRETTY PLEASE THANK YOU KINDLY FOR YOUR TIME WE HOPE THAT THERE IS ANOTHER DAY AND TIME AFTER THIS DATE OF SEPTEMBER 20,2017 PLEASE LET US KNOW RIGHT AWAY IF YOU WOULD BE SO KIND AS TO LET US KNOW THANK YOU KINDLY PLEASE HAVE A REALLY NICE DAY .
    YOURS TRULY
    PENNY M.

  3. David Hodgson

    IS THERE GOING TO BE ANY MORE OF YOUR WEBINAR ( CLASSES ? ) A FEW DAYS AFTER THE DATE THAT YOU HAVE HERE LISTED ON SEPTEMBER 20TH ,2017 AT 9:00 A.M. ??? PLEASE LET US KNOW THAT WOULD BE DAVID AND PENNY PLEASE LET US KNOW SOON IF YOU WOULD BE SO KIND AS TO DO SO THANK YOU PLEASE HAVE A REALLY NICE DAY .
    YOURS TRULY
    PENNY

  4. Barry L Hohstadt

    Hi Dave, thanks for a great article. I was released from CH 13 six months ago. I have been told that traditional financing will require 7 years seasoning after the CH 13. So I am very curious how you friend financed his home after just 3 years. Thanks

  5. Ihe O.

    Credit scores do not measure credit worthiness they measure how profitable you are to the credit industry. If you keep up your payments – especially hefty interest payments, you can have a high credit score despite that you may barely be solvent. Whereas if you run a high balance because of you are taking advantage of low interest or interest free offers your credit score could easily dip below 600.

    Credit scores do not indicate the likelihood of default on rental real estate for 2 reasons.
    1. Credit scoring companies do not keep track of your record of rental payments and so it has not an input to the scoring algorithm.
    2. Peoples attitude to debt that relates to the roof over their head cannot be extrapolated from their attitude other forms of less essential debt.

    Apart from these relatively major mistatements the article is fine.

  6. John Murray

    I have been in the RI biz for a good long time. The credit game is pretty much rigged. Here is the specific I that noticed. The 760 threshold is a key factor in the credit score. I’m a BRRRR guy and no matter what refinancing incurred my score will never drop below the 760 threshold, ever! I take up to 4-5 mortgage loans per year and it’s always the same story 765 to 780. In summery the 760 score will always be the hallmark of the active RI. If my credit score would ever drop below this mark, the other investors lose money. It is all about profit and nothing else.

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