Those who don’t understand the real estate investment market assume that one must have sterling credit to be an investor. While it certainly doesn’t hurt to have an 800 FICO score, most of us don’t—but we can still get a seat at the table even with a subprime score.
According to Experian, one in five people have what is considered to be “deep subprime scores,” and at the same time, the number of people with “superprime” scores is dropping. To make it worse, lenders are responding to the credit crisis by raising their credit threshold, effectively changing how we define “good credit.” The result is that fewer people than ever have it.
The good news is that having bad credit doesn’t have to mean you can’t be a real estate buyer or investor. It’s a lot more common than you might realize, that investors buy hundreds of houses a year while having the worst credit scores imaginable. How is buying a home possible in that case?
Land contract doesn’t require good credit
When you buy a home on a land contract (sometimes referred to as a “wraparound mortgage”), the bank isn’t involved, so you don’t have to meet their standards. A land contract is simply a private contract between a buyer and seller, where the buyer agrees to pay the seller monthly payments and interest over time in exchange for the property. In essence, the seller is his own mortgage banker.
There are several situations where a seller would be motivated to sell on a land contract. It could be for example, that the property is an “ugly house” that needs repair, and would not pass the inspection that a conventional lender would require. Or, the seller could be in a financially distressed situation and need to get out from under the mortgage, but the market is too soft to facilitate a quick sale with conventional financing. And while the seller may well pull a credit report, more often than not, they won’t. It’s up to the buyer to convince the seller that he or she is creditworthy. Searching online for “buying a home” or “buying a home ny” will bring you a clearer picture.
Land contract is sometimes referred to as a “wraparound mortgage” because it “wraps around” an existing bank loan. In this case, the seller receives the monthly proceeds from the buyer, uses it to make his own monthly payments, and pockets the balance as profit. The seller actually has very little at risk, but the buyer needs to do some due diligence and take a leap of faith. Because this type of contract is subject to existing mortgages, if the seller takes all of your monthly payment and takes a trip to Hawaii instead of paying the existing mortgage, the bank will default on the seller. When that happens, you’re out of luck, because the bank does not recognize a land contract buyer as a legitimate owner. The way around that is to structure your land contract to give you some guarantees; for example, structure it so that your payments are divided—you pay your seller’s mortgage payment directly, and then make an additional payment to the seller for the balance between your land contract payment and the seller’s underlying mortgage payment. That leaves you in control – a control to selling or buying a home ny confidently.