A common misconception about hard money lending is that credit score makes no difference. As the thinking goes, borrowers don’t really have to worry about their credit scores because lenders are only focused on the value and sale potential of collateral. It turns out that such thinking does not reflect reality.
Hard money lenders, like Salt Lake City’s Actium Partners, generally give very little weight to credit score when determining loan eligibility. But they still do check credit scores to get a better idea of risk. In many cases, a client’s credit score influences the deal that is eventually offered. So yes, credit score is still important.
It’s All About Interest
Loan eligibility is about collateral more than anything else. Interest rates are not. Hard Money lenders do pay attention to credit score just like retail and commercial banksbecause it is very helpful for gauging risk. Higher risk profiles lead to higher interest rates.
In the simplest possible terms, a borrower’s credit score and history contribute to determining the interest rate he or she will pay. This suggests that hard money borrowers should not treat their credit scores lightly. They should be just as diligent as they would if they had plans to approach a retail bank for a traditional loan.
Understand the FICO Formula
Though using the FICO formula for determining credit worthiness is voluntary, the majority of lenders and creditors rely on it. It is a formula that was developed in the 1950s to provide a numerical representation of how likely a borrower is to default on a loan within the first few months. The higher the number, the lower the risk.
The FICO formula is broken down into several areas represented by the amount of weight assigned to them in the equation:
Payment history – 35%
Current debt load – 30%
Length of credit history – 15%
Credit types – 10%
Recent credit searches – 10%.
Note that these are general guidelines. The FICO formula is somewhat flexible. It allows creditors to make adjustments based on their own needs and preferences. One lender can place more emphasis on payment history while another is more concerned about current debt load, for example.
Maintaining a Good Credit Score
Knowing that credit score can affect hard money interest rates, it seems reasonable that borrowers would want to do everything within their power to protect it. After all, there is no point in paying higher interest rates if one can avoid it. So how do hard money borrowers maintain good credit scores? By doing the following:
Paying Bills on Time – A history of late payments negatively impacts credit score. Unfortunately, late payments represent risk that lenders do not want. So, maintaining a good credit score starts with paying bills on time.
Reducing Debt Load – Debt load puts downward pressure on limited financial resources. As such, reducing one’s debt load can have a positive impact on credit score. Borrowers should pay down as much debt as possible, as quickly as they can.
Request Credit Increases – The FICO formula takes into account a borrower’s debt load as a percentage of total available credit. The lower the ratio between the two, the better it is for a borrower’s credit score. This suggests that borrowers can request credit limit increases but not borrow any more. This would lower the debt load ratio even more.
Credit score may not influence a hard money lender’s decision regarding loan eligibility, but it almost always affects interest rates. As such, hard money borrowers should be concerned about maintaining the highest credit score possible.