Ben Dorland

How does your FICO score impact your interest rate on your loan?

Low credit scores are deemed greater risk for lenders since the likelihood for defaulting on the loan increases. As such, lower FICO scores translate into higher interest rates. Mortgage lenders will group credit scores in a range, usually in 20 or 40 point increments, with interest rates progressively getting better for each higher interval. For example, a borrower with a middle credit score between 660 - 680 will have a higher interest rate (presuming all other variables being equal) compared to one with a 680 - 700 score. Typically, when a borrower has a 750+ credit, they will be able to secure the best possible rate, assuming their income, assets, collateral and down payment are acceptable.

For qualifying, underwriters use the middle credit score pulled from the three bureaus versus an average of the three. For instance, a borrower with scores of 702, 717 and 749 would have a 717 FICO compared to an average score of 722. If there is more than one borrower on the loan, the lender will use the lowest middle score of all borrowers versus the middle score of the primary wage earner, like many lenders used to do. Often times, a husband and wife will have drastically different scores. When that occurs, it is best to qualify off of only the person with the good credit. However, if a spouse or partner is left off of the loan (they can still go on title though), none of their income or assets can be used to help qualify. Therefore, the sole qualifying person must have ample liquid assets, as well as gross monthly income to stay below the lender's allowable debt-to-income ratio.

What is a FICO score?

FICO stands for Fair Isaac Corporation, a company that created the most used credit scoring model in the United States. An individual's credit score is calculated through a statistical algorithm and is used as a factor in determining the likelihood of a borrower defaulting on a loan. FICO scores are generally used for obtaining mortgages, car loans or consumer credit. The scores are provided from the three major credit reporting agencies: Equifax, Experian and Transunion. Typically, there is a variance amongst the scores since each agency has a slightly different scoring formula. FICO scores range from 300 - 850, with higher scores being considered less risky. For mortgage lending purposes, any score over a 680 is considered good and above a 750 is considered excellent. Any score below 580 is considered great risk and will be challenging for such a borrower to secure financing.

The factors that contribute to a FICO score and the weighted percentages for each are as follows:

• 35% - timeliness of payments (adverse dings to scores for any payment greater than 30 days later, collections, past due accounts)
• 30% - the ratio of used debt to allowable debt for consumer credit (an individual that maxes out their credit cards will see a decrease in their score)
• 15% - length of credit history (the more credit history and showing proof of consistent timely payment, the better the score)
• 10% - types of credit used (installment, revolving, mortgage)
• 10% - recent credit inquiries and recent new credit (taking out a fair amount of new credit with multiple credit inquires can adversely impact a score)

One of the most important aspects of a successful transaction is performing due diligence. I am referring to deals for both your personal investments and your clients transactions. I do not want to go into too much detail about due diligence on all deals, because every deal is different. Especially when you are talking the differences between a development opportunity, commercial, or residential. What I do want to talk about is a very brief overview of something I heard from Bradley Zieg of Turnkey Investments. Brad spoke at our most recent Denver Athletic Club Real Estate Club meeting and I came away with three very important points.

1. You must first take action to get the wheels in motion.
2. Have a workflow and plan for each transaction.
3. Use experts that are on your team to help with the process.

Here is a brief breakdown of each point from my point of view

1. Know your market and if a deal presents itself you need to take action immediately. Either get the deal under contract or have your team get things in motion. Paralysis by analysis will get you nowhere, use your tools and team so you know when a deal is a deal and take action. Always give yourself a legitimate "out" if the deal is not what you first thought it was.
2. Just like your business, you must have a plan for each transaction. Have a workflow for deals and know who to call at different points during the transaction. Also, a workflow helps you remember each part of the process so you do not overlook anything.
3. This may be the most important point of the three. Do not try to be the jack of all trades. You need real estate experts, financial experts, construction experts, PR experts, legal experts, accounting experts..........etc. Let each team member do their job and help your transaction be successful.

Please let me know if you have any other ideas on Due diligence. Contact me if you have questions or would like to see an examle of our deal analysis systems.

Investor often ask me what types of real estate investments are available on the market. Here's what we tell them.

This is the first of several postings on the topic.

Please offer comments - positive or negative!

Assignments. If you don't have much equity to work with, and/or if your credit power is limited, assignments can be a way to get started in real estate investing. You will need to have a strong "sales" personality to succeed at it, though.

Rental Condo or Rental Home. Purchase of a residential property to be rented out to tenants, usually on a 6-12 month lease term. This is how most new landlords get started. You can hire out all of the property management functions, but in many cases you will do many of them on your own. There are smaller down payment requirements than for larger rental buildings. The purchase process and financing process is very similar to what you experienced buying the home you live in now. It's a great way for beginners to get started.

Small (2-4 units) Apartment Building. Purchase of duplex, triplex or quadplex to be rented to tenants, usually for 6-12 month terms. Usually what the rental home / condo landlords graduate to. In most markets they cost a little more than a rental home, but are much more likely to cash flow on the average month. Less cash flow risk; if one unit is empty you have other tenants that still help you with the mortgage payment so it doesn't all come out of your pocket. Many owners will start to delegate some of the property management tasks to an on-site assistant (typically the most responsible tenant), such as yard maintenance and showing empty units. The financing process is only slightly more involved than a residential loan. Relatively small down payment requirements make it affordable. The purchase process is also very similar to purchasing a home. It's a good way for beginners to get started.

Large (5+ unit) Apartment Building. Still targeting tenants for 6-12 months at a time, buildings with more than five units are considered "commercial" property. The loans are more difficult to qualify for, and usually a larger down payment is needed. Uncommon for the new investor; this is usually what landlords with several years of experience "trade up" to. Cash flows on larger buildings are more stable than for smaller buildings, and the economies of scale make it practical (and desirable) to hire a property manager to take over most the work for you. This takes reduces the hassle factor of the landlord process.

Lease Options. Again you are seeking a tenant for a property, but usually for a slightly longer term (12-18 months) and frequently (though not always) with the goal that the tenant purchase the property from you at the end of the lease. If you purchase the property, then it's an easier process; if you find a highly motivated seller to let you re-lease the property to another tenant, it can be a lot of work to set up. However, the re-lease method doesn't require any cash out of pocket and does not rely on your credit score, so it is appealing to many investors. Great for beginners with the right skills and attitude.

Fix and Flips. Purchasing a home that needs work. The scope can range from the basic "paint and carpet" to extensive overhauls to scraping a decrepit property and completely starting over. Usually does not involve tenants, and the objective is to get in and out of the property as quickly as possible. Great for beginners with the right skill sets or the willingness to learn.

Conversion of Apartments into Condos. A synthesis of the fix and flip and rental operations - purchasing an apartment building in a neighborhood dominated by owner occupants, then converting the building from apartment building to condominium. Often requires renovation of the units to meet the expectations of owner-occupant buyers in that area. Complex and time consuming, but has wonderful tax advantages compares to fix and flips and often has superior returns to all other asset classes. Ideally suited for the sophisticated investor with extensive experience.

Scrapes, Pops and New Construction. Purchasing a small home in an expensive neighborhood that may or may not need work. The home is bulldozed and a new home or duplex is put on the lot. Alternatively, the existing home is renovated and more square footage is added on. A pop-top is adding a second story to an existing home to add more square footage (commonly, a master bedroom suite).

(c) Copyright 2008 Your Castle Real Estate

Recap of First Half 2008 Home Price Performance

The average home price in Metro Denver increased +2% in the full year 2005 to the full year 2006. Comparing 2006 to 2007, the average home price across the metro dropped 3%, to $303,000. The half of 2008 was $275,000 vs. the first half of 2007 was $306,000: a 10% decrease. These numbers will be slightly different than Metrolist, as they are just Denver Metro and don't include outlying areas like Fort Collins, Colorado Springs, or Boulder.

The average price of a foreclosure dropped -6% to $168,000 in the first half of 2008. The average short sale was steady at $212,000. The average price of a non-distress sale decreased 5% to $352,000. Sales volume was down for single family homes. Foreclosure and short sale volume is up and non-distress seller volume is down.

Some areas did better than others. The attached chart shows different neighborhoods in our region. Each region has the neighborhood's name and the percentage of sales in the last twelve months that were either short sales or bank-owned properties. The second line has the price change the twelve months from July 2007 to June 2008 vs. the twelve months immediately preceding. Next, you'll see the average home price in the last twelve months and the average days on market (DOM) in the last twelve months.

There had to be at least twenty sales in the last year for an area to be included. The numbers are more reliable in areas where there were more sales.

The good news is the last four times the market had a change from a buyers market to a sellers market, or vice versa, it was preceded by a change in the DOM. DOM for homes declined in the first and second quarters of this year. Too soon to call it a trend, but it is a favorable sign. Another great indication of hitting the bottom: monthly prices in DSW and AUN have been relatively steady for seven months, after falling rapidly from 2005 to 2007.


Source: Your Castle Real Estate analysis, MLS data


(c) Copyright 2008 Your Castle Real Estate