Credit Scores — How Residential vs. Commercial Real Estate Lenders Consider Them

Credit Scores are used very differently between residential real estate lenders and commercial real estate lenders.

What is a credit score?

A credit score is a numerical representation of an individual’s creditworthiness and risk level as a borrower. It is based on information in a credit report, which is a detailed record of an individual’s credit history. Credit scores range from 300 to 850, with higher scores indicating lower risk to lenders. Equifax, Experian, and Transunion are three agencies that monitor these scores and produce reports detailing credit history.

Overview

Credit scores are an important factor in both residential and commercial real estate financing, but they may be viewed differently depending on the lender and the specific loan product. In general, lenders use credit scores to assess the creditworthiness of an applicant and the risk of lending money to them. Higher credit scores may be viewed more favorably by lenders because they indicate a lower risk of default.

Even though credit scores typically range from 300 to 850, the range of scores considered “good” or “excellent” may differ between residential and commercial financing. For example, a credit score of 720 or above may be considered “good” for residential financing, while a score of 700 or above may be considered “good” for commercial financing.

Credit Scores in Residential Real Estate

In the case of residential real estate mortgages, credit scores are used to determine the interest rate and terms of the loan. In general, borrowers with higher credit scores are offered lower interest rates and better terms because they are considered to be a lower risk to the lender.

Here are some ways that credit scores can impact a residential mortgage application:

1. Interest rate: Borrowers with higher credit scores may be offered lower interest rates on their mortgage, as they are considered less risky to lend to. This can result in significant savings over the life of the loan.
2. Loan approval: Credit scores are used to determine whether a borrower is eligible for a mortgage and the terms of the loan. Borrowers with higher credit scores have a better chance of being approved for a mortgage.
3. Down payment: Some mortgage programs require a down payment, and the amount of the down payment may depend on the borrower’s credit score. Borrowers with higher credit scores may be required to make a smaller down payment.
4. Discount Points: Points (expressed as a % of the loan amount) can be paid by a borrower in order to buy down the interest rate. Borrowers with higher credit scores typically receive more favorable discount points to be able to buy down the interest rate at a lower cost.

Credit Scores in Commercial Real Estate

In the case of commercial real estate financing, credit scores may also be used to assess the risk of lending money to a borrower. However, lenders may also consider other factors, such as the borrower’s experience in real estate, the location and condition of the property, and the financial performance of the borrower’s business.

Unlike residential real estate where a very low credit score makes it almost impossible to qualify, commercial lenders might be able to mitigate risk by requiring additional collateral or a personal guarantee from the borrower.

Additionally, there are some commercial lenders that only look at the asset’s financial performance and will not even consider a borrower’s credit score. For example, if you have a single-tenant retail building with a very strong tenant (i.e. Apple) signed to a long-term lease, the lender does not care much for the borrower’s personal credit score because they rely on Apple’s strong balance sheet.

Conclusion

Overall, credit scores are just one factor that lenders consider when making lending decisions. It is important for borrowers to understand their credit score and work to improve it, but it is not the only factor that lenders will consider when evaluating a loan application.

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Good luck out there my friends.

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