The lease option purchase method is a great way to invest in real estate. However, when you do, knowing how to screen tenant buyers is an important skill that you'll want to master. It should be clear to you from the beginning that people wanting to purchase on a lease option are almost certain to have credit problems. When you learn how to screen tenant buyers, you can limit your risk and maximize the probability that the purchase will be completed.
How to Screen Tenant Buyers to Minimize Risk
Millions of people had their credit score seriously damaged during the Great Recession. There are also millions of people that have been working to restore their credit score since then. That makes now a great time to be in the lease option purchase business and creates a huge pool of qualified potential buyers.
The first thing to consider about how to screen tenant buyers is the cost of pulling multiple credit reports. You may find a qualified applicant with the first application or you may go through seven or eight before finding one that is acceptable to you. At $35 to $45 a pop to pull their credit reports, you don't want the burden of this cost. A motivated applicant that believes they will qualify should be willing to pay this fee up front.
It takes seven years for a credit problem to fall off of a person's credit report. That means you will likely find occurrences of when people had a temporary credit problem caused by the high unemployment rates and rampant foreclosures during the recession. Those events are a thing of the past. As each month passes, these count less and less against their credit score. The most qualified tenant buyers will have a rising credit score over the past several years.
How to Screen Tenant Buyers - The Right Credit Score
How to screen tenant buyers can be a challenge when deciding what an acceptable credit score is. The Federal Housing Authority (FHA) sets minimum scores that vary depending on a multitude of things. These include what program is being applied for and the amount of down payment being made. However, ultimately the FHA guarantees the loan but doesn't originate the loan. Originating the loan is done by individual banks that set their own credit score standards. Still, the FHA standard is the logical place to begin when considering an acceptable credit score.
Generally, the FHA requires a FICO score of at least 580 to qualify for a low down payment loan guarantee. Exceptions can be made for FICO scores between 500 and 579 if a down payment of 10% or more is being made. For those with a credit score below 500, about the only ones that qualify are those meeting the requirements of FHA 203(h) - Mortgage Insurance for Disaster Victims.
How to screen tenant buyers involves more than just the credit score. You also want to look at their employment history. They may have lost a job during the times of high unemployment. But how many jobs have they had since the economy started recovering? Many of the jobs first created when the economy started coming back were lowing paying jobs. You should see applicants that originally took these low paying jobs and then traded up to better paying jobs. Those are most likely motivated people that will complete the lease purchase. People that have repeatedly changed jobs by moving from one low paying job to another probably have an employment problem. These people are much less likely to improve their credit score and/or complete the purchase.
These are the basics for how to screen tenant buyers. If you want to learn more advanced methods, leave a comment below or contact my office at wendypatton.com/contact.
By Wendy Patton
For more than 30 years, I've used the Sandwich Lease Option System to earn myself and my students millions of dollars. From my experience, I know there is plenty of room and opportunity in the real estate investment market for everyone wanting to participate to find profitable deals. It's because of that fact and my personal success that I share the Sandwich Lease Option System with others.
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