Imagine, if you will.
The banking industry, trillions of dollars strong, hired smart people to create a secret formula using all the data legally available to quickly and accurately predict the likelihood that a person would repay a consumer debt. How impactful would that tool be?
Well, it is out there. It is the FICO® Score.
A FICO® Score is a three-digit number predicting how likely someone is to repay a loan. FICO® stands for Fair Isaac Corporation and is the dominant brand in the credit scoring industry. For our purpose, it is interchangeable with the term “credit score,” like using Kleenex® to describe “tissue paper.”
The calculation of the FICO® Score uses a top-secret proprietary formula using information from your credit report. According to the Fair Isaac Corporation, its weight is determined by Payment History (35%), Amount Owed (30%), Length of Credit History (15%), Credit Mix (10%), and New Credit (10%).
FICO® ranks the scores as follows:
- Less than 580 is Poor
- 580 to 669 is Fair
- 670- 739 is Good
- 740 – 799 is Very Good
- 800+ is Exceptional
Most homebuyers and property investors seeking a loan already understand that their credit score is important. If you are getting a loan, you will want the best terms and the lowest interest rate possible. The FICO® Score is key, and most people buying property have already considered it.
Unfortunately, most landlords and tenants aren’t aware of how important FICO scores are to them. Here are the reasons why:
For landlords, the most reliable predictor of collecting future rent from a prospective tenant is their credit score. The longer we do this, the more we have come to see it is true.
Of course, landlords may have to be a little more flexible for a $1,200 per month apartment with no AC on the side of a busy road than for a $6,500 luxury unit or a $12,000 per month beach home. Landlords need reasonable expectations fitting the market for their property. It is unlikely that a starter apartment in certain low-income areas will have applicants with 750 FICO scores. Landlords may have to take on some credit risk to fill that vacancy. Whereas it is reasonable that people paying $5,000 or $10,000 or more per month in rent have higher-rated credit.
We can address things landlords can do when an applicant does not qualify as standalone, like using co-signers, some other time. However, for now, remember that the most sophisticated consumer lenders in the world rely heavily on credit scores. They are more advantageous absorbing a payment default than most small property owners. This is especially true in this post-COVID, pro-tenant era where is harder than ever to get rid of a non-performing tenant.
Now let’s examine this from the tenant’s point of view keeping in mind it is harder to evict a non-paying tenant. This makes landlords extra careful about whom they rent to. One of the unintended results of all these new, well-intended, tenant protection measures is that it is harder for a prospective tenant with credit challenges to secure housing.
Through all the fair housing requirements used to reduce unfair biases, landlords may limit to use of numbers such as ratios and credit scores when evaluating tenants. The tenant’s story and explanation may not matter.
Our advice to tenants is to protect their credit because it may be improbable to secure housing with poor credit.
Understanding the importance of credit scores is the first step in turning them into a tool that can help. Landlords can benefit from them just like the banks do. Property investors, home shoppers, and tenants can all benefit from the advantages that a good credit score provides when they understand how it all works.
Dunfee Real Estate Services, Inc.
DRE # 02026232