The Common Reason to Lower Credit Scores | CRE

Your credit score is a vital component of your financial health, especially when navigating the world of Commercial Real Estate (CRE). A good credit score opens doors to better loan terms, lower interest rates, and more favorable financing options. Conversely, a poor credit score can severely limit your opportunities and make securing funding for your CRE ventures a significant challenge.

Understanding the factors that influence your credit score is crucial for maintaining a healthy financial profile. While various factors contribute to your credit score, there's one particularly common culprit that consistently leads to lower credit scores, impacting individuals and businesses alike. This article will delve into this critical factor and provide actionable steps you can take to avoid its detrimental effects, particularly within the context of CRE financing.

The Culprit: High Credit Utilization Ratio

The most common reason for a lowering credit score, particularly impacting those seeking CRE financing, is a high credit utilization ratio. But what exactly is credit utilization, and why is it so important?

Credit utilization refers to the amount of credit you're currently using compared to your total available credit. It's expressed as a percentage. For example, if you have a credit card with a $10,000 limit and you've charged $5,000 to it, your credit utilization ratio is 50%.

Why Credit Utilization Matters

Credit utilization is a significant factor in calculating your credit score, typically accounting for around 30% of your FICO score. Credit bureaus view high credit utilization as a sign of potential financial distress. It suggests that you're heavily reliant on credit and may have difficulty managing your debt obligations. This perception translates to a higher risk in the eyes of lenders, leading to a lower credit score.

In the CRE world, this is exceptionally important. Lenders reviewing your business or personal financials as a part of due diligence for a commercial loan will see a high utilization as a red flag. They may worry about your ability to successfully service debt, especially given the larger amounts borrowed in commercial real estate.

The Impact on CRE Financing

Imagine you're applying for a commercial mortgage to purchase an office building. You've found the perfect property, developed a solid business plan, and are ready to secure financing. However, your credit score is lower than expected due to high credit utilization. This situation can lead to several unfavorable outcomes:

• Higher Interest Rates: Lenders will perceive you as a higher risk borrower and compensate by offering you a higher interest rate. This can significantly increase the overall cost of your loan and reduce your profitability.
• Reduced Loan Amount: You may qualify for a smaller loan amount than you need to complete the purchase. This could force you to seek alternative, potentially more expensive, funding sources or even abandon the deal altogether.
• Loan Denial: In severe cases, your loan application may be denied altogether, preventing you from pursuing your CRE investment.
• Stricter Loan Covenants: Even if approved, you may face stricter loan covenants, giving the lender more control over your business operations.

Understanding Good vs. Bad Credit Utilization

So, what constitutes a good credit utilization ratio, and when does it start to negatively impact your credit score?

• Excellent: Under 10% - Demonstrates responsible credit management and is highly favorable to lenders.
• Good: 10% to 29% - Shows good credit habits and shouldn't significantly impact your score.
• Fair: 30% to 49% - May begin to negatively impact your credit score, especially if combined with other negative factors.
• Poor: 50% and above - Significantly damages your credit score and raises concerns for lenders. This is especially harmful when seeking CRE financing.

It's crucial to keep your credit utilization below 30% and ideally strive for under 10% to maximize your credit score benefits.

Strategies to Lower Credit Utilization and Improve Your Credit Score (CRE Focused)

Fortunately, lowering your credit utilization and improving your credit score is achievable with a proactive approach. Here are some effective strategies to implement, with a specific focus on how they can be applied in the context of commercial real estate:

1. Pay Down Your Balances: This is the most direct way to reduce your credit utilization. Focus on paying down balances on credit cards with the highest interest rates first, then tackle other balances. For CRE, this means strategically using cash flow from existing properties to pay down lines of credit used for property management or tenant improvements.
2. Increase Your Credit Limits: Requesting a credit limit increase on your existing credit cards can also lower your credit utilization ratio. However, avoid the temptation to spend more just because you have a higher limit. Responsible spending is key. For CRE, consider business credit lines that are used and paid off regularly for supplies and operations. Increasing the limits here can help.
3. Open a New Credit Card: Opening a new credit card can increase your overall available credit, thereby lowering your credit utilization. However, only pursue this option if you can manage another credit card responsibly. Don't open multiple cards at once. For CRE, consider opening a business card specifically designed for real estate expenses (like rewards for home improvement stores).
4. Consider Balance Transfers: If you have high-interest debt on one card, consider transferring it to a card with a lower interest rate. This can save you money on interest charges and free up funds to pay down your balances faster. For CRE, think about consolidating smaller vendor bills or construction expenses onto a single, lower-interest card.
5. Become an Authorized User: Ask a trusted friend or family member with a low credit utilization and a positive credit history to add you as an authorized user on their credit card. This can positively impact your credit score. Be cautious of the potential downsides if the primary cardholder mismanages their account. This is less applicable to CRE directly, but still relevant for personal credit scores impacting loan guarantees.
6. Monitor Your Credit Report Regularly: Check your credit report regularly for errors or inaccuracies. Dispute any errors you find with the credit bureaus. This is especially important when applying for CRE financing as even small errors can raise questions. Utilize services like AnnualCreditReport.com to access free credit reports from the three major bureaus.
7. Plan Ahead for Large Expenses: If you know you'll be incurring a large expense, such as tenant improvements or property upgrades, plan ahead by saving money or exploring alternative financing options to avoid relying heavily on credit cards. Consider lines of credit specifically for these kinds of capital improvements.
8. Automate Payments: Set up automatic payments to ensure you never miss a payment. Late payments can significantly damage your credit score. Automating payments ensures you consistently pay at least the minimum amount due, contributing to a positive payment history. For CRE-related credit cards, automate payments directly from your business bank account.
9. Negotiate with Creditors (If Necessary): If you're struggling to manage your debt, consider negotiating with your creditors. They may be willing to lower your interest rates, create a payment plan, or offer other forms of assistance. This is particularly relevant if your CRE business has faced unexpected challenges impacting cash flow.
10. Prioritize Debt Repayment: When managing multiple debts, prioritize repayment based on interest rates. Focus on paying down high-interest debts first, even if it means making smaller payments on lower-interest debts. This strategy minimizes your overall interest costs and accelerates your debt repayment process. Again, focus on cards used for CRE operations with high APRs.

Long-Term Strategies for Building a Strong Credit Profile for CRE Ventures

Building a strong credit profile is a marathon, not a sprint. While short-term strategies can help you lower your credit utilization and improve your credit score quickly, it's essential to adopt long-term habits that promote responsible credit management.

• Maintain a Positive Payment History: Consistent, on-time payments are the foundation of a good credit score. Make sure to pay all your bills on time, every time.
• Avoid Applying for Too Much Credit: Applying for too many credit cards or loans in a short period can negatively impact your credit score. Each application triggers a hard inquiry on your credit report, which can temporarily lower your score.
• Diversify Your Credit Mix: Having a mix of different types of credit, such as credit cards, installment loans (like auto loans or mortgages), and lines of credit, can demonstrate responsible credit management and improve your credit score. When it comes to CRE, this can mean having a mix of mortgages, lines of credit for operations, and business credit cards.
• Build Business Credit Separately: Establish a separate credit profile for your CRE business. This separates your personal credit from your business credit, protecting your personal assets and potentially opening up more financing options.

The Importance of Professional Guidance

Navigating the complexities of credit scores and CRE financing can be challenging. If you're unsure about the best strategies for improving your credit score or securing funding for your CRE ventures, consider seeking professional guidance from a financial advisor or a credit counselor. They can provide personalized advice and help you develop a plan that meets your specific needs.