How To Invest In Real Estate If You Have Bad Credit

It seems like every time you turn on the television, there's a new home improvement show dedicated to flipping houses and making bank—a popular way to invest in real estate. 

Investing in real estate and turning it for a profit might be tempting. But if your credit score is below 601—the number the credit bureaus mark as the dividing line between “fair” and “bad” credit—you might have a tough time finding funding.

So, is investing in real estate out of the question for someone in that bunch? Not necessarily.

Buying an investment property vs. buying your own home

No matter what you've seen on TV, purchasing real estate as an investor is a lot more complicated than doing so as a homeowner if you are turning to a lender to help finance the deal.

"Those looking to finance the purchase of real estate as an investment—as opposed to a primary residence—can expect a higher interest rate and more stringent lending criteria from lenders before getting a mortgage," explains Bruce Elliott, president of the Orlando Regional REALTOR® Association and a broker associate with Regal R.E. Professionals in Orlando, FL.

Lenders typically require more money down and a better credit score for a real estate investment loan than for an owner-occupied home loan.

"They also look very carefully to ensure that investment home buyers are financially capable of sustaining the mortgage over an extended period of time in the event that the property doesn’t resell, and they even have formulas to calculate for shortages in expected rental income," Elliott explains.

Can you invest in real estate with bad credit?

Unless you have spare cash or a loan from a friend or relative to finance your investment, obtaining a loan will likely be difficult.

That said, there are other options to help you one day become a real estate investor, Elliott says.

• Improve your credit score. Resolve any collection-related issues uncovered by a credit check, and pay down existing balances. And be smart about other investments: Now is not the time to finance additional purchases such as a car or to open additional credit accounts of any type.
• Find a hard money lender.
No, this isn't a back alley deal-maker. Hard money lenders are private individuals or groups who will put up cash for real estate ventures, and they are often more amenable to making a deal with someone who has poor credit. Of course, there will be some drawbacks: "Generally, these lenders will require anywhere from 40% to 60% down to purchase or close outright," Elliott notes.
• Skip putting money down.
It might sound like a pipe dream, but Elliott says this is often the story behind those roadside “home for sale” signs that specify "cash only.” "The investor simply has purchased an option or received permission from a homeowner to try to sell the home," he explains. "The investor makes money either from a back-to-back closing or from payment directly from the ultimate buyer."

If you want to invest in real estate, bad credit can be a stumbling block, but it doesn’t have to derail the whole train.

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Ways to Invest in Real Estate

If you’re looking to diversify your investments, real estate can be a lucrative venture. There are several ways you can dip your toes into real estate investment waters. Take a look at the categories below to see if one of them is right for you.

Real Estate Investment Groups

If you want to invest in rental properties but don’t want to deal with the day-to-day obligations of being a landlord, real estate investment groups are a great option. A company buys or builds apartments and allows investors to hold the lease on one or more units, while they handle the basics. The company receives a portion of each month’s rent in exchange for its services. Lease holders also typically contribute a percentage of rent to a pool that covers vacancies, providing payment even if the unit stands empty for a month or two.

Be sure to thoroughly research the groups you’re considering. Investment groups are usually safe, but it all depends on who you’re doing business with.

Standard Rentals

Rental properties can cover mortgage payments when tenants are in residence, which then turns to profit once the debt is paid off. Unless you hire a property manager, you’ll be responsible for any maintenance. Figure on spending around 50 percent of your monthly income to keep the property in top shape. 

Property can appreciate between the time of purchase and the final mortgage payment, netting you a tidy profit if the market is right. Work with an area realtor to determine the best time and location to buy and sell.

Real Estate Investment Trusts

REITs are a step further removed from first-hand ownership than investment groups. Around 200 are publicly traded, and their financial records can be easily researched as a result. Trusts or corporations purchase rental properties with investor funds and are required to pay out 90 percent of the taxable profits in dividends. REIT investments provide regular income and are easily liquidated, but you’ll need to do your homework to ensure your investment is sound.

Real Estate Trading

Real estate trading is property investment on steroids. Similar to stock market day trading, it can be both risky and rewarding. Investors hold properties for a 3-4 month period, and then ideally sell for a profit. Real estate traders gamble on undervalued properties and hot commodities to “flip” the investments they’ve made.

If a trader makes the right picks, there’s a lot of money to be made, but one wrong move can send it all crashing down. Because the properties are not held for long periods, most investors don’t keep cash on hand to pay mortgages for extended periods of time, and may have cash tied up in multiple properties.

There’s a less risky way to flip properties, but it is more labor intensive. These investors live in a home while they improve it, and then sell it for a higher price once the renovations are made. Although only one property at a time is typically flipped, there is significantly less risk of failure.

Several methods of real estate investment exist, all with varying levels of risk, reward and involvement. Research your chosen method and the companies involved to make the decision that’s right for your portfolio.