Does My Credit Score Matter For Commercial Real Estate?Paul Winterowd
If you are a real estate investor that is new to the commercial lending space, you might be wondering why lenders would want to know your personal credit score.
It drives me a little bit crazy when I hear the “gurus” selling training programs that commercial is brilliant because it is just asset-based lending, and all that matters is how the real estate performs…
It is only a half truth.
It makes sense that lenders base decisions on your property’s financial performance, cost basis, ability to support the debt, the operating pro forma, and even your personal financial statement which shows your net worth and liquidity.
But why should commercial real estate lenders care about your personal credit history?
Your personal credit score tells people how creditworthy you have been throughout your personal financial life – at least for the last
7 to 10 years.
As you repay (or fail to repay) personal loans for college, your credit card debt, or the mortgage on your house, lenders report your history to credit bureaus like Experian and Transunion.
If you pay your bills on time, you do not max out your existing lines of credit, and you avoid charge offs and other negative reports, you will have a good-to-excellent personal credit score.
Our credit score is our first, and most important, calculation of how creditworthy we are.
There is a fairly obvious answer to the question of why commercial real estate (CRE) lenders care about our personal credit: Why shouldn’t they?
Quality CRE lenders will only offer you a loan only if you are a good bet to pay them back. And if there’s information out there that tells them otherwise, they will want to know about it.
The truth is, once your personal credit score dips below 650, it does not matter how good your property financials look—you are going to get denied for the best multifamily loans. This is especially true for elite programs like Fannie, Freddie and HUD.
You may be able to swing a loan from a second-tier lender since their requirements are less stringent and are more focused on the asset’s performance rather than yours. But if you do get accepted, it will be at rates (interest rates, repayment terms) that are much less friendly. The lender knows they can charge more because you are considered a higher risk with poor credit history.
If you have a low credit score and want to get in the multifamily game, your first step is to clean up your personal credit history and get back on the right track in your personal spending life.
Check your personal credit history now to see where you are.
The typical rite of passage for commercial real estate loans is 680. So, I recommend doing what you need to do to keep it 700 or above.
Additionally – if there are any past judgements, collections or charge offs, get them settled. Some lenders will make that a requirement for loan approval anyway so its best to get it taken care of now.
These are usually small dollar amounts in comparison to the millions of dollars you can potentially borrower against the real estate you are buying.
If you credit history is less than stellar now, or you know of past foreclosures, bankruptcies, or charge offs, prepare a Letter of Explanation (LOE). This letter should detail the situation(s), show remorse, highlight lessons learned, and express your complete commitment to never going down that path of poor repayment practices ever again. This LOE can help you still get the loan.
Parting thought – Leverage is one of the greatest beauties of real estate, and to maximize the benefits of the leverage potentially available to you, make every effort to keep your personal credit score high and credit history clean.