Investors get trapped in a credit usage cycle – here’s how it happens.
We get calls about this bad credit trap almost daily. Let’s go over the story of one client.
They were going for a DSCR loan. They owned the property free and clear – except they had put all the repairs on their personal credit cards, which they still owed. It’s not uncommon for investors to use credit cards to cover the rehab costs of a flip. In this case, they ran around $40,000 on the cards.
So they went to get their DSCR refinance of up to $210,000 on this property that was worth over $300,000. The LTV looked good, everything was checking out, and they actually got pre-qualified before they did all the work and got the tenants in the property.
Then the problem: their points rose from 1 to 3%. Their interest rate went from mid-7s to over 9.6%. Their LTV jumped from 70% down to 65%.
Why? Those credit card balances were on their personal cards, so it impacted their personal credit. The bad credit score impacted their rate and fees. Now, for this refinance they had already qualified for, they now owed over $6,000 in points alone.
What Is the Credit Usage Cycle?
On flips and BRRRRs, we see this credit cycle happen over and over again.
Investors put the fix-up costs (business expenses) on personal cards. This drives up the balances, and so increases credit usage, and so lowers their personal credit score.
In the earlier example, our client fully intended to use the money from the refinance to pay off the credit card balances. But they can’t get the refinance until the cards are paid off. This is the cycle.
In most instances, you expect to pay the personal cards off with the refinance. But when you go to refinance, you get the unexpected surprise that your credit score doesn’t qualify. In our client’s example, he had actually pre-qualified, but the rate and fees had changed drastically due to the bad credit score.
If this client had accepted the terms of that refinance, he’s going to get less cash out to pay off the cards and put into his next project. The next property will have hefty out-of-pocket closing costs. With all these extra costs, his real estate investing career will slow to a standstill, and he’ll be more dependent on the personal credit cards than ever.
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