“How do you get bad credit?” and “How do you fix bad credit?” are all essential questions to ask, but they shouldn’t preclude you from asking, “How do I invest with bad credit?” In this article, we’ll explore options for investing in real estate when your credit is far from ideal.
What is Bad Credit?
Simply put, bad credit results from not paying your bills on time or accruing too much debt.
There are all sorts of reasons this may happen:
- Medical bills.
- Student debt.
- Credit cards.
- Identify theft.
- Poor economic conditions.
- Poor budgeting and spending habits.
Introduced in 1989 by the data analytics company FICO (originally Fair, Isaac and Company), your credit is assessed by what’s known as a FICO score, which is a measure of how risky it is for you to have credit based on your history. Here’s what your score means:
- Exceptional: 800+
- Very good: 740–799
- Good: 670–739
- Fair: 580–669
- Poor: 579 and lower
What Sort of Loans Can You Get With Bad Credit?
Traditionally, homes are paid for using fixed-rate mortgages. This is true even of investors using more advanced investment strategies like the BRRR Method. Traditional homes tend to require a credit score of 620 or higher. If your score is less, you can still qualify for the following options.
- FHA: 580 or higher credit score qualifies for 3.5% down (lower than 580 may require 10% down)
- VA: Most lenders want to see 580-620.
- USDA: Most lenders want to see 580-640.
- Fannie Mae HomeReady (for low and moderate-income borrowers): 620 or higher credit scores can qualify for 3% down.
See our complete guide to financing investment property for a more in-depth discussion of VA and FHA loans.
How to Buy a Home With Bad Credit
A partnership is one of many real estate legal entities you can set up for the purpose of investing. A partnership is a business with two or more legal persons (or entities) joined together.
The benefit of a partnership is that its participants can complement each other. In this case, someone with better credit would partner with you because you might be more driven, have superior business acumen, an abundance of time, etc.
There are several types of partnerships you can enter into, each with their benefits. The type of partnership you choose will dictate how much paperwork, if any, will be required. Some partnerships can be informal, requiring no paperwork and only a verbal agreement.
- LLC-Partnerships: This is a legal and tax entity with at least two participants. These are ideal for real estate ownership because they come with many tax benefits and less risk of being audited by the IRS.
- Limited Partnership (LP): Formed under state limited partnership statutes, LPs have at least one general partner and one limited partner. An LP is what’s known as a pass-through entity, an entity that income passes through before ending up in the LP’s owners and investors’ pockets. An LP files partnership tax forms and gets many of the tax benefits as a partnership. An LP, however, is entirely subject to passive loss limits, which means it doesn’t get to deduct any rental property losses against other forms of income.
Hard Money Lenders
Hard money lenders tend not to look at the borrower’s credit score because they care more about the deal’s security. They want to ensure that if the borrower defaults, they can foreclose on the property and sell it.
In exchange for overlooking the credit score, hard money lenders have stricter conditions.
- Interest ranges from 10 to 18%
- Loan terms range from 6 to 24 months
- Higher fees (“points”) can add upwards of 3% to 10% to the loan amount.
The short terms of a hard money loan make it appealing for house flipping and the BRRR investment strategy since you don’t need a long-term loan.
To find a hard money lender, just Google local “hard money lenders.” You can also go to local Real Estate Investors Association (REIA) meetings and ask around.
Once you find a hard money lender, make sure they’re reputable.
- Ask for references.
- See if there are any complaints filed with the Better Business Bureau against your potential lender.
- Ensure that at least one person associated with the hard money lender has a valid real estate license without any complaints filed against it.
Private Money Lenders
Hard money lenders tend to be real estate professionals. Private money lenders, meanwhile, are simply individuals with money who want to invest. That means your private money lender can be anyone!
Since a private money lender is unlikely to be an investment professional, they’re unlikely to ask for a credit score. However, a private money lender is also most likely someone you know well enough to lend you money in the first place, so you don’t want to enter into such an arrangement unless you’re confident you’ll be able to pay back the investment. A good rule of thumb is not to borrow money from anyone who can’t afford to lose it.
Owner financing, also known as seller financing, is when the buyer and seller determine the loan conditions. After the loan is negotiated, the buyer will start making interest and principal payments directly to the owner.
Owner financing has the advantage of allowing the seller to seal the deal faster. However, the owner takes on greater risk because they’re on the hook if the buyer defaults. As a form of insurance, the owner may ask for a more significant downpayment that can range from 3% to 20%.
This risk may be worth it for the owner because the monthly income will be greater since they’ll be getting interest and principal payments. And for the buyer, the advantage is the increased flexibility that comes with dealing with the owner directly. Plus, the buyer may enjoy the savings that come with having lower closing costs by not dealing with a bank.
It’s crucial, though, for the buyer to make sure that the seller owns the property outright. If the owner has a mortgage on the home, their lender could foreclose the due-on-sale clause, a mortgage contract stipulation that dictates that the mortgage must be paid off entirely before the house can be sold. The due-on-sale clause is meant to protect the mortgage holder, most often a bank, from the possibility of a mortgage being transferred or sold to a new owner when the mortgage’s interest rates are below the market’s current rate.
You’ll need to look for owner financing options.
- Vacant Homes: Drive around your neighborhood and contact the owners of any vacant homes you see and contact the owner. You may also find signs for homes that say “for sale by owner.”
- Absentee Landlords: An absentee landlord is someone who doesn’t live in the investment property they own. You can buy lists of absentee landlords on websites like RealQuest.com or ListSource.com.
- Real Estate Industry Gatherings: Again, local meetings of your REIA are a great place to network. >
Wholesaling is when you find a great deal, put the house under contract, and then sell them as quickly as possible to a cash buyer for a greater amount. It’s possible to complete such a transaction without ever using your own money or even getting a credit check.
If wholesaling sounds too good to be true, it’s only because you don’t know how much work it requires. You’ll have to.
- Find a seller and negotiate the price and terms, and then put together an agreement to purchase their property.
- Find a buyer to purchase in your place. This can be someone who will rehab the home or an investor.
- The buyer you found then purchases the property per the stipulations of the deal you’ve arranged.
- The buyer becomes the homeowner, the seller gets paid, and you get an “assignment” fee for making it all happen.
As you can tell, wholesaling is a lot of work!
- Wholesaling requires your undivided attention.
- Wholesaling takes time, patience, and a knack for marketing. You have to:
- Talk with sellers on the phone.
- Sell yourself as someone who can sell their property for them.
- Estimate rehab costs.
- Find cash buyers.
- Pull it all off without the deal da.
- Wholesaling has legal implications.
- Wholesaling makes use of all the skills a real estate agent would have.
- Wholesaling requires putting together the plan of what it would take to flip or invest in a property without actually flipping the house or investing in it.
House hacking is when you rent out your primary residence. House hacking isn’t just limited to owners of multi-family homes who rent out unused units. Owners of single-family homes can rent out bedrooms, basements, and attics as well. House hacking is an effective way of mitigating risk while generating an income stream.
Get a Second Mortgage
If you’re a homeowner, you can get a second mortgage. A bad credit score has less impact on a second mortgage because it will be backed up by the property you already own. Just make sure you have enough income to make payments on your second mortgage, no matter your investment property’s status. If you can’t make your payment, you’ll put your home and investment property in jeopardy!
Save Money For a Big Down Payment
If you can provide a down payment of 20% or more up front, you may qualify for loans that would usually require a better credit score. That’s because a large sum up front demonstrates an ability to manage finances and financial stability. You might end up with a higher-than-usual interest rate, but you’ll still have the money to make your investment.
Real estate investment trusts (REITs) is a company that owns and manages properties. Publicly traded REITs are REITs that you can buy and sell on the stock market, allowing you to invest in real estate with poor credit and without having to get involved with property ownership.
One of the additional advantages of REITs is that they have to pay out 90% of their taxable income to shareholders. This makes it harder for REITs to grow in size but makes them a steady source of income.
Fix Your Credit
Before, after, or instead of investing with no or bad credit, you’ll want to improve your credit score. It’ll take work, but it will also make you a better investor, make investing easier, and help you better manage your finances. Consider the following options.
- Make more money: Easier said than done, but you’ll have to do this to take care of your debt more effectively. That may mean everything from putting in more hours to finding additional work.
- Lower your balance: A high debt-to-limit ratio makes your credit worse, so try to get your debt to be less than 30% consistently.
- Stop applying for credit: Each time you apply, your score takes a ding.
- Think about a secured credit card: A secured credit card is a credit card whose maximum limit is determined by the amount of money you deposit with the lender. If you give $2,200, then the limit on your secured credit card will be $2,200. If you use this card to make purchases that you’ve already budgeted for–food, gas, etc.– then you’ll be able to build your credit back up with less risk.
You can invest in real estate without money, so of course, you can invest in real estate with bad credit. That doesn’t mean you shouldn’t be actively working on getting good credit, though. Bad credit can be a symptom of poor money management skills, which would undermine any investment you make. So if you choose to make use of any of these investment strategies for bad credit, make sure you’re still working on getting good credit.