Real Estate Risk Manager

As I’m sure you already know, when financial institutions approve you for a credit card or a loan, you are assigned a credit limit.

Let’s say you have:

• VISA – $5000 limit
• The Children’s Place card – $1,000 limit
• Unsecured Line of Credit – $10,000 limit

 If you max them all out with an intention to pay minimum payments only, next time you apply for credit an unpleasant surprise might be waiting for you!!

LENDERS WILL SEE IT AS AN OVER-RELIANCE ON CREDIT, AND TRY TO MANAGE THEIR RISK AGAINST YOU POSSIBLY OVER-EXTENDING AND DEFAULTING ON PAYMENTS.

WHAT DO LENDERS WANT TO SEE?

Lenders like to see that you use your credit products and pay them off, or even if you carry balances, they are manageable at your income level.

Makes sense, I think???

• Credit scoring models  give you most points for utilization up to approximately 30% of your credit limit. 
• That shows them that you manage your credit file well, and are responsible. 
• They start getting a little nervous if your balances top 50% of your credit limit.
• Go over 75%, and risk averse bankers will have a panic attack , and your credit scores start dropping like a rock! 

Recently, one real estate investor raised some good questions on www.myreinspace.com.

He wanted to understand how utilizing your credit lines impact credit scores.  Are all credit products created equal, i.e. if you maximize your secured line of credit, unsecured line of credit, or a credit card – will the resulting impact on your credit score be the same or different?

Let’s walk through an example. 

Four people have a credit limit of $10,000 each.  Each of them has a $10,000 balance.

But:

• Person A carries this balance on a secured line of credit
• Person B on an unsecured line of credit
• Person C on a VISA, and
• Person D on a department store card

Let’s assume all four have exactly the same income and identical credit files in good standing. 

Who do you think would worry you more?

• Person A pays interest only on his secured line of credit at prime rate.  That is $25 per month.
• Person B pays interest only on his unsecured line of credit (yes, there are unsecured lines like this) at prime + 4%.  That’s $58 per month.
• Person C pays 3% of balance plus annual interest rate of 18%.  That’s $450 per month.
• Person D pays 3% of balance plus annual interest rate of 28%.  That’s $533 per month.

This very simplistic example demonstrates: credit products are not created equal!!!!  They pose different levels of risk to lenders, and different levels of stress on your ability to pay.

SO WHAT’S BEST?

Clearly, the Home Equity Line of Credit’s (HELOC) secured line of credit is the safest.

It is secured against equity in your house, and your payment is the lowest of the pack.

If you were to use it for investment purposes (utilizing it to the max.), it would not hit your credit score anywhere near what, say a department store card would.

BEST APPROACH:

Avoid carrying balances and paying minimum payments on your credit cards.

Pay them off IN FULL, EVERY MONTH, when the balance is due!!!

 OH AND BY THE WAY… ALWAYS BACK TO OUR TENANTS…

WHEN YOU QUALIFY A TENANT, THIS IS SOMETHING TO KEEP IN MIND!! 

If your prospect tenant has several credit cards on their credit bureau file with high utilization, you can easily add up the payments they have to carry every month and see what portion of their income goes towards servicing debt.

At the end, do they still have enough to pay rent?

Best of Luck!

If you are an ambitious, entrepreneurial type who thinks real estate is the vehicle that will take you to riches, building your credit is a task you will have to undertake.

Mortgages, lines of credit, and construction loans may all become necessary at some point. To qualify for them, you will need established credit history and good credit score.

Likewise, Rent to Own tenants need to qualify for a mortgage when the option term is up and they are ready to buy the property from you.

So how do you prepare your or your tenant’s credit?

Going through this exercise yourself will help you build your own credit history, and give you good understanding of the steps involved.

A LITTLE BACKGROUND:

In the past, it was easier. Prior to the credit crunch of 2008, I helped my own Rent to Own tenants build their credit history by applying for so-called Department Store private label cards.

Many department stores offered their private label cards, and even offered you some discounts off your first purchase as an incentive to sign up. So even if you did not have any credit history yet, they often were willing to take the risk and approve you for your first credit card. The Bay, Zellers, Peoples, Mappins, the Children’s Place, and the Home Depot were all willing to get you started on your path to building credit.

All you had to do once you were in possession of your shiny new credit card was use it on a regular basis for a few months for nominal amounts and make your payments on time, in full. Six months later you could go to your bank branch and apply for their VISA or MasterCard. By then you would have established sufficient credit history and solid enough credit score to qualify for their card. Onward and upward!

Follow the same strategy for with your new bank card, and 6-12 months later your credit is ready for a mortgage application.

My tenants did it, and ended up buying their first ever home!!!

TODAY:

Does this strategy still work?

In some cases, yes. But after most financial institutions tightened their lending criteria in 2008, applicants with no or little credit histories were among the first ones to be targeted by risk managers. But, not to worry. Not all is lost.

I investigated what is available these days for those interested in starting to build their credit history, and came across an interesting product by Capital One.

A guaranteed secured MasterCard. Looks like a good start.

With a security deposit as low as $75, annual fee of $59, and annual interest rate of 19.8%, you can start establishing your credit! Use it to buy whatever you buy anyway, BUT REMEMBER pay it in full every month and on time. In 6-12 months you will be ready to apply for many other credit products, and really establish yourself strongly.

Best of luck!

You wrote a great ad, took pictures, received many calls and walked potential tenants through the property until you finally selected someone who seemed like a good fit.

You pull their credit file only to find there was nothing in their file!   Now what?  How did this happen?

Likely, this happened because of one of two possible scenarios:

1. No record at the credit bureau file, known as a “no hit”; or
2. A file exists, but there are no credit trade lines, and no score, known as a “thin file”

Individuals falling into either of these scenarios tend to be very risky!! 

As a Credit Risk Manager, it is my job to analyze the behaviour of various segments of population on an aggregate level.  And in my experience, customers with no credit history approved without any additional selection criteria are going to lose you money.

HOWEVER, among them there are people who can make descent tenants!! 

LET’S REVIEW SOME STRATEGIES WHICH WILL HELP YOU SELECT THE BEST OF THEM.

1. NO HITS

The Credit Bureau tells you that there is no information about this person in their databases.

One approach is to ask the potential tenant to provide their Social Insurance Number (SIN) to help you accurately access their application.

**Keep in mind, providing SIN is optional, so don’t be surprised if they refuse.** 

The SIN is the best identifier of an individual.  Other information may not be accurately captured by the credit bureau.  Inaccuracies may include:

• Phone numbers
• Date of Birth
• Address

A “no hit” might occur simply due to inaccurate information at the bureau.  In which case, it is in your applicant’s best interest to cooperate by providing their SIN.

**If that does not help, another approach is to use a different credit bureau.  If you primarily use Equifax, then try to pull a file from Trans Union, and vice versa.** 

Now, if the result is still a no hit, credit will not be a factor in your decision.  You will need to rely more on so-called demographic information such as income, time at previous address, time at job.

Look for signs of stability (STRATEGY).

 STABILITY INDICATORS:

• Minimum of two years at previous address
• Two years at current employment confirmed by their employer
• Rent to Income Ratio of no more than 35%
• Favourable review from their present landlord

These indicators will show if your potential tenant tends to live in one place for some time, has employment stability, and has sufficient income to pay rent.

Using these indicators, you can still select the best tenants from this otherwise risky group.

2. THIN FILE

While different credit grantors have different definitions of thin files, for the purposes of tenant selection I would stick with this:

The credit file exists, however a Beacon Score does not exist and the applicant has no credit trade history.

 First, let’s discuss which of these are the most risky.  If you see:

• The file contains derogatory public records such as Bankruptcy, Foreclosure, Repossession, Judgments, Collection items, Tax Defaults, OR
• The applicant is a credit seeker (please read my last article “Curious George Learn About Credit Inquiries” to learn more about this).  Since there is no other credit information, anything above 2 inquiries in the last 6 months is too much, in my opinion.

**These are very risky, and are more likely to default on their rent payments at some point in the next 12 months.** 

 If however, neither of these scenarios appear and they have a clean file with no or very few credit inquiries, refer to the “stability” indicators mentioned above in the No Hits section.

Absence of credit does not have to be a bad thing, if otherwise the applicant behaviour is responsible.

BIT OF ADVICE:

EVEN with very little Credit Information, you can use whatever is available to protect your business!

Congratulations!  Next time your applicant has no credit history, you are equipped with strategies to approve the best of them.   

Every time you apply for a credit card, mortgage, new mobile telephone, car loan, etc., you give lenders permission to pull your credit bureau file information, which in turn creates a credit inquiry.

Lenders report those to the credit bureaus, and credit bureaus return the favour by letting all other lenders know what your credit appetite is.

The more credit inquiries you generate in a short period of time, like 6 months or 12 months, the closer you are to being viewed as a “credit seeker”.  That raises a RED FLAG for lenders!!!!!

What if you have credit inquires? 

• 1 or 2 inquiries will not raise concern;
• 3 or 4 will draw some attention to what kind of credit you are seeking

Credit bureaus provide a code to illustrate the type of credit you are interested in – be it mortgages, car loans, credit cards, etc.

So if they see that your 3 inquiries were all for a mortgage or a car loan within a very short period of time (say 1 month), they often attribute it to “shopping for the best interest rate”, and count these as one inquiry.   This rule does not apply if the mortgage inquiries were made in different months!

Good to know, huh?

However, in my experience, once you clinch 5 or more credit inquiries in 6 months, you will win a title of a credit seeker in the eyes of the financial institutions, and they will look at you under the microscope.

They will have a few questions (same questions you should be asking your prospective tenants):

• What are you planning to do with the new credit?
• Is there a chance you took over somebody else’s information fraudulently, and are trying to go shopping on their dime?
• Do you need credit because you are having a shortage of cash, and want new credit cards so you can “borrow from Paul to pay Peter”?
• If you use up your new credit limits, are you still going to be able to pay your other bills or rent to your landlord?

What will this mean to your overall CREDIT SCORE?

Grand scheme of things, credit inquiries contribute about 10% to your Beacon score.

You need to be aware of your credit inquiries over time.  Six months is the usual period of time used by credit grantors.

So while the exact Beacon score weights are proprietary, here is my guesstimated price of being a Credit Curious George:

0-2 inquiries in last 6 months – negligible impact (no more than 10 points)
3-4 inquiries in last 6 months – some impact (could be up to 20 points)
5+ inquiries in last 6 months – noticeable impact (20 to 50 points)

 Another fact to be aware of is that some credit scoring models lenders use count the number of new trade lines opened recently (6 months or 12 months).  The more credit cards and loans you obtained recently, the more points you will lose off your credit score!  Talk about double dip…

Investors beware!  In Canada, mortgages, for the most part, do not appear as trade lines on your credit file, so you safe!

How does this play out when buying Real Estate?

If you have a solid credit file with Beacon score of 760, and you bought 3 properties over the last 6 months, generating 3 inquiries, you can continue planning your new acquisitions confidently.  

However, if you have Beacon score of 650, and in the last 6 months you obtained 3 new credit cards, a car loan, and a brand new mobile phone with Rogers, you might not be able to qualify for a mortgage on that rental property.

Some suggestions:

• Apply for credit ONLY when necessary!

• If you buy multiple properties in a short period of time, review your credit file with your mortgage broker to ensure the bank will continue saying “Yes”.

• If you are applying for a mortgage with a financial institution where you already have an established relationship (VISA, MasterCard, mortgage, loan, etc.), ask if they can make a “soft inquiry”.  (Periodically they refresh your credit bureau information anyway, without it counting towards your inquiries.  Known as a soft inquiry, it won’t impact you!)

• Don’t think this is just for financial institutions!  Examine inquiries made by your tenants in the last 3 to 6 months.  Are they credit seekers?

Happy Investing!

Part 1 – What is in Your Credit File?

You may already have a tentative idea what kind of property you want, where, and how much you have for a down payment.

So what now?

As an Investor, getting a mortgage and picking a tenant are going to be two of the most important tasks you have!

So let’s say you raid your desk drawers, file organizers, and bank boxes to dig out the CRA summaries of your income tax filings, mutual fund statements, home value and mortgage balance, etc., and armed with those documents, you apply for a mortgage.

AND GET TURNED DOWN!

I expect your bank representative will explain to you that there is something “derogatory” in your credit file, so it’s a NO GO.

And so ends the birth of the next Donald Trump.

Knowing what is in your credit file and how to manage it could have prevented the embarrassment!

The more you know about how credit works, the better prepared you are whether qualifying for mortgages or selecting great tenants.

Before we look at what’s in your credit file, let’s say you qualified for that mortgage and are now a proud owner of your first rental property.

Now the real work begins – finding the perfect tenant!

Here’s a very real SCENARIO:

Having met with a few potential candidates for your new tenants, you really like a young couple with a newborn baby. Their parents said they are nice kids. Very pleased with how your business is moving along, you approve their application, and look forward to great cash flow from your property. A few months later, this nice couple tenants inform you — they can’t pay the rent!!

Shocked? Wondering what went wrong?

As a seasoned investor and risk manager, my first question is: did you pull their credit files?

Had you done so, perhaps you would have found out their student loans were 90 days past due, their credit cards were maxed out, and there was a judgment against them because they never paid for that big screen TV proudly standing in their living room.

What do you think the odds are that you will see your rent money?

Could you have prevented having them as your tenants?

You bet!

Because how they do anything is how they do everything!!

Credit/spending behaviours can be used to understand better how they pay their bills, ALLOWING YOU TO MITIGATE YOUR RISK AND NOT RENT TO THE WRONG PERSON.

Do they pay on time, or are they habitually late? Or worse yet, do they just decide NOT to pay them at all. Have they ever declared bankruptcy?

Do sometimes people get in over their heads? Sure. But, if it is repeated behaviour, you NEED to know!

Those who are late paying their credit card and Bell Canada bills will very likely be late paying you rent as well!

So, what’s in Your Credit File (and what will you find in your tenant’s credit file)?

Canadian lending institutions generally report what they know about your credit behavior to the credit bureaus, Equifax and Trans Union, on a monthly basis.

What do they report?

1. Credit Inquiries

Every time you apply for a credit card, mortgage, a new mobile telephone, car loan, etc., it is called a credit inquiry.

Lenders report them to the credit bureaus, and credit bureaus return the favour by letting all other lenders know what your credit appetite is.

2. Trade Lines

This is pretty much represented by every piece of plastic you have in your wallet!

Flashy names like VISA, Master Card, American Express, Diners, store credit cards like the Home Depot, Staples, HBC will appear on your credit bureau file as a separate line.

Oh, and don’t forget your car loans, student loans, personal line of credit, the $2,000 vacuum cleaner you financed with Citi Financial or HSBC.

They are ALL reported to the credit bureaus, and are called trade lines or trades.

Interestingly, one type of credit trade line which frequently is not reported to the credit bureaus, is the largest one for most people – mortgage. Without getting into a deep discussion of the reasons, I will just state that owning 50 properties, and hence, servicing 50 mortgages, does not mean you will have 50 mortgage trade lines on your credit bureau file.

BUT BE WARNED: If you choose to carry a mortgage via a Personal Line of Credit such as Scotiabank’s STEP program offers, you will generate a trade line on your bureau file. Though, if you generally manage your credit file well, there will be little negative impact. Home Equity Line of Credit (HELOC) is a great tool to have when you are an investor, as it allows you to write a cheque on the down payment for your investment property.

3.  Debt Burden/Utilization

As I’m sure you already know, when financial institutions approve you for a credit card or a loan, you are assigned a credit limit.  Let’s say you have:

• VISA – $5000 limit
• The Children’s Place card – $1,000 limit
• Home Improvement Loan – $10,000 limit

Along with credit limits, credit file shows your balances. A simple mathematical formula will show how much of your credit limit you utilize:

Utilization = Balance / Credit Limit

If you max your credit cards with an intention to pay minimum payments only, next time you apply for credit an unpleasant surprise might be waiting for you.

4.  Delinquency history

Here’s a real no no!!!!

Credit statements have a “Due Date” for a reason. If no payment arrives by that date, the credit account becomes past due or delinquent.In the Delinquency History and the next section, Derogatory Public Records, credit lenders GET TO TELL everybody authorized by you to view your credit history whether you have been naughty or nice as a credit customer.

5.  Derogatory Public Records

Basically, this is a continuation of the naughty behavior consequences.

• Declared bankruptcy?
• Lost your house to a foreclosure?
• Skipped paying taxes?
• Decided not to pay your mobile phone bill to Rogers?
• Got evicted via Housing Tribunal judgment?

Guess what? Derogatory Public Records snitch on you. If your potential tenant has these items, you are better off without them!

Now that you know what’s in your credit file, please join me for Part 2 (coming soon) where you will learn how to interpret and analyze what all of this means piece by piece!!

Are you a Canadian Real Estate Investor? Even if you aren’t yet, but are thinking about making income property part of your Investment portfolio, welcome to my blog!

You are in the right place!

Imagine having a Magic Book of Investment tricks, full of Risk-free strategies guaranteed to make you great returns. Ever wonder how much easier life would be if you knew the money you invest will always make you more money? Well, while I cannot eliminate all Risk from your Investments (sorry!), I can share specific approaches that helped me considerably reduce the likelihood of losing money when buying rental property.

Even tycoons like Donald Trump sometimes lose in the Investment Game – though he wins even more often!

Like me, I’m sure you want to increase the odds of success in your favour, don’t you?

I discuss investing in Real Estate with my friends, family, neighbours and colleagues. The most frequent questions I hear are: “What if I lose my money?”, “How Risky is it?”, “What if the tenants do not pay rent?”, “What if Real Estate market crashes?”

Newspaper headlines scream Doomsday messages to bewildered Investors, convincing them to keep their money in the savings accounts, T-bills, and GICs. And of course, the housing market meltdown in the United States left many people shaken, anxiously awaiting a similar crash in Canada. THEN of course, our loving friends and family members echo the Newspapers with their horror stories of some friend of a distant relative’s cousin, who invested and lost money.

So what are we supposed to do? What will make our money work hard for us, ensuring a secure retirement, education fund for the kids, memorable vacations? Banking the money and watching inflation erode its purchasing power?

Read More