Most people invest in real estate using conventional loans from financial institutions because buying real estate outright can become very expensive. However, when you have bad or no credit, the process of qualifying for a conventional loan can also be quite difficult.
Financial institutions use your creditworthiness, a combination of your credit score and credit history, to determine if you qualify for a conventional loan. The better credit you have, the more competitive of a loan you qualify for.
Experian identifies individuals with bad credit as having a FICO credit score between 300 and 579. However, it can still be difficult to obtain a conventional loan if your FICO is under 600. So if you happen to be in this category of having bad credit or no credit, you should consider investing in real estate using these five methods.
1. Invest with a Partner
If you can't qualify for a conventional loan because you have bad or no credit, finding an investment partner who can obtain a conventional loan could be a great alternative.
Typically you will want to find a partner who has the skills or resources that you are lacking.
In this example, because you are lacking good credit, you would need to find someone who has good or excellent credit to help you finance your potential property.
This happens to be just one way to form a real estate investing partnership; however, you can structure your partnership anyway you and your partner see fit. Keep in mind that you must truly bring value to the partnership or no one will want to partner with you.
Some examples of valuable skills in real estate investing are:
A Construction Skillset
Property Management Knowledge
Contract Writing (Real Estate Agent or Lawyer)
Regardless of how you decide to structure your partnership to obtain the financing for your investment property, ensure you do it legally. Once you and your partner have come to an agreement, seek out a lawyer to help you both with the paperwork.
Before forming a partnership, you must clearly identify what type of partner you are looking for. Consider using these questions below to guide you along the way:
Will your partner be solely providing the financing for the investment property or will your partner help manage the property after it is bought?
Are you both going to put down half the money for the downpayment on the property?
Are you both 50/50 partners splitting the equity in the property and cash flow?
2. Consider Using Seller Financing
Seller financing, also known as owner financing, is when a buyer finances a property directly from the seller of the property. This financing offer is extremely flexible because, in most cases, no bank or government requirement must be met.
So if you have bad or no credit, seller financing will give you the ability to work out how you would like to acquire the property, while disregarding your credit situation. The biggest caveat is that the seller has the final approval of the financing for the deal.
Typically, you and the seller identify the ideal structure for the down payment, interest rate, and loan term based on both of your needs.
Once you and the seller have come to an agreement to buy the property, you both will sign a promissory note detailing all the terms of the loan the seller created for you. If you, the buyer, defaults on the loan, the seller still holds the title and full rights of the property.
If you are thinking about using seller financing, do your best to make the situation mutually beneficial for both parties. As a buyer with bad or no credit, seek out sellers who you can actually help.
For example, some real estate investors use seller financing to relieve their tax burden of selling an entire property in a given tax year. Seller financing would allow the investor to extend the profits of selling their property over a period of years.
3. Use a Hard Money Lender
Hard money lenders are individuals or a group of individuals who can offer a loan for your investment property.
Hard money lenders are unique because they are not solely focused on your credit score or credit history, but instead are really interested in the success of the investment property you are looking to purchase.
When considering a hard money loan, you must understand how to analyze an investment property and know what makes a good real estate investment deal. If the real estate investment property is not a good deal, the hard money lender will not fund your investment property.
Even if you have bad or no credit and you have a good deal, the hard money lender will move forward with the loan and may just charge you a higher interest fee because of your credit.
The greatest downside of utilizing hard money lending is that it is expensive and uses your investment property as collateral if you don’t pay back your loan.
Typically hard money loans can have an interest rate of 10-18%, which is very expensive compared to the average conventional loan rate in 2020 of 3%.
If you fail to pay the loan back, the hard money lender will take full ownership of your property.
4. Locate a Private Money Lender
Using private money lenders can be another reasonable resource to help fund your investment property with bad or no credit.
Private money lenders are usually people or a group of people who are looking for a return on a real estate investment, but choose not to actively invest in real estate.
This may be an individual who has a lot of money and doesn't want to take the time to learn about real estate investing, but would like to invest their money in the asset class.
Like hard money lenders, private money lenders are looking at your investment deal’s quality and value rather than your credit score and history.
Usually, because these are independent entities and don't have to adhere to regulations and corporate policies, they are willing to negotiate the loan term, interest rates, and truly anything else within the real estate deal.
5. No Credit, Try Manual Underwriting
If you fit in the category of having no credit, but have a steady job and the down payment for the investment property, you should consider manual underwriting. Manual underwriting is simply a manual process conducted by a person to evaluate your ability to repay a loan.
This is very typical for people who may be new to using credit and have never had a loan in their name.
The process of manual underwriting can be cumbersome, and you will be required to provide additional paperwork to complete the process. Extra paperwork is needed because financial institutions usually gauge your ability to repay a loan based on your credit score and history.
Most of the additional paperwork will be related to your previous payment history such as rent, utility bills, and insurance premiums. The manual underwriter will also consider your cash reserves amount for the property and that you have a low debt to income ratio based on his or her company opinion.
Which Option is Right for You?
Of course, the answer varies depending on your investing goals, but you should consider forming a partnership.
Zelite conducted a survey of 20 real estate investors and based on their recommendations, forming a partnership is by far the most popular of the five strategies.
However, over half of the investors cited that fixing your credit should still be a priority before starting your real estate investment journey. The graphic below displays some tips to improve your credit.
If you want to learn more about real estate investing —head over to the Zelite app!