The Changing Nature of a Credit Score
This past July, the three major credit reporting bureaus quietly changed their formula for how credit scores are calculated. Certain things from the past are simply being deleted to make records more accurate. But before we get into that, let's think about how this affects landlords.
There are two ways:
- It affects landlords who are securing financing for future properties
- It affects what tenants may or may not meet your tenant screening criteria
Let's start with the first one. A real estate investor with excellent credit can get a mortgage on a rental property in the 5-6% range these days. Another investor with less than stellar credit could pay far higher interest up to 12-15% if they were even offered the same loan. Most likely our 2nd investor would need a far larger down payment. If the algorithm behind credit scores changes, suddenly, our 2nd investor with the not-so-great credit can qualify for lower down payments and better interest rates. But banks and other companies aren't just going to swallow the extra risk or cost associated with lending money to people who appear to be mid-level borrowers. The price of borrowing through interest or points will simply increase and the reward for having good credit and being financially responsible with be less pronounced.
The 2nd way is how it affects your criteria for tenant selection. One of the things credit bureaus are doing is excluding judgments and tax liens if they don't include the consumer's full name, current address, and either their social security number or date of birth. They also get excluded if they haven't been updated in the last 90 days. Most judgments and tax liens don't include this information and aren't up to date and in July these records evaporated. If you can't see that someone has a judgment they might look better on paper than they actually are in real life. The knock-on effect of this is that the incentive to pay off these old debts is greatly reduced, even from evictions. Medical debt now has a 6 month waiting period due to the fact that in cases of car accidents and other situations, there can be a dispute over who should pay certain medical bills. Those bills are often sent to collections while the patient and their insurance company work out the details. Rather than appearing on the credit report right away and lowering the person's score, it won't appear for 6 months.
How did this all start? Politics of course.
Congress ordered a report by the Federal Trade Commission to examine credit reporting agencies and their accuracy of their reports. The report found that 1 in 5 consumers had an error with at least one of the 4 big bureaus. The FTC has demanded that the bureaus get better at reporting. On top of that several state attorney generals brought lawsuits against the bureaus and as a part of the settlement of those lawsuits the bureaus had to remove data from their algorithm including whether consumers paid bills like gym memberships and traffic tickets. The Consumer Financial Protection Bureau, in their recommendations, ordered the credit bureaus to remove judgment and lien data from the algorithm.
On the bright side, because of this change your credit score may have increased. On the downside, the next time you have to screen tenants for tenant selection, their credit report may not be strictly reflective of everything that has gone on in their life.
In other words, it isn't the credit bureau’s fault. Their hands are tied. While these changes artificially make lower-end borrowers have greater attraction, it can mean a big bonus for investors who can acquire money at much better rates. You can grow your rental housing portfolio at a faster rate with better loan terms.
So much of life is now determined by a credit score. It touches almost every area of life where money is involved. We can’t control how the scoring system works but we can work within the system. Write solid criteria for tenants and use the rules to your advantage to grow your business.