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You know all about the benefits of buying a house – how it helps you build wealth through equity, how you can potentially save money on a mortgage via expensive rent, how it becomes a home and a safe and secure place to live your life to the fullest. But there’s one problem: your credit is low. What do you do? Will you be able to get a lender to help you despite being marked as a lending risk?

And how can you meaningfully improve your credit?

While having low credit doesn’t necessarily bar you from getting a mortgage – especially with programs like First Merchants’ Next Horizons program, which uses alternative means to establish credit for those with a limited credit history or low credit scores – it helps to think ahead and to try and improve it if you are able.

Luckily, there are a number of ways to do that, shared Dawn Elliott, Mortgage Banker with First Merchants Bank (NMLS: 1098510).

“The important thing is to remember that you have options,” she said.


Find Your Starting Point

The first step to repairing your credit is to get a clear picture of where you are and know your goal.

“If you’re going to work on fixing your credit, starting early is important – so if you’re going to buy a house next year, start now,” Dawn encouraged.

If you haven’t already, take advantage of a credit monitoring service – like the one offered for free through First Merchants Bank’s mobile app – to keep an eye on how your score dips or climbs. Keep in mind that this score is a little different than what will turn up when you apply for a mortgage, but it’s still a good starting point.

“The scores that show up on those services are what we call a consumer credit score, and they’re used if you’re buying a car or applying for a credit score,” Dawn explained. “The credit score we use to determine if you qualify for a mortgage is a bit different – it’s a deeper dive. And that’s just because mortgages are heavily regulated, so the expectation is a little bit different. But a consumer credit score is still a great way to get a ballpark of where you are.”

Next, consider what type of mortgage you’ll apply for, and double check the minimum required credit score.

For example:

  • A Next Horizons Mortgage loan with First Merchants requires a credit score of 600 – though with this program, other variables are considered in addition to creditworthiness.
  • A Federal Housing Authority (FHA) loan prefers that borrowers have a credit score of 621 – though lower scores may be accepted.
  • A USDA loan prefers that borrowers have a credit score of 640 or higher.

Finally, consider your time frame. Are you planning to buy a house within the year? In two years? Longer? This can help you plan your credit-improvement strategy – but remember to be patient.

"Unfortunately, it just takes time. Especially if your credit is low due to a short credit history,” Dawn said.


Get Credit Counseling

In fact, when Dawn gets a client with a low credit score, one of the first things she does is refer them to a credit or free housing counselor.

“There are plenty of local, free organizations that will provide you with a personal counselor who will help you work on collections that need to be paid or to get back in the habit of making your payments on time,” Dawn said.

While it may be tempting to pay for a credit repair company, Dawn advises her clients to go with the free services for several reasons.

“Housing counselors work to help you address the underlying issues and get you in a good position to purchase a home,” she explained. “Often, paid services encourage you to dispute every debt or to negotiate payments. While there are times when that’s a good course of action, if you’re applying for a mortgage, it’s recommended that you don’t have disputes on collections. That can result in delays as you may be required to resolve those disputes.”

If you want to purchase a home in the near future, it is better to work to resolve debts quickly, if possible, rather than kicking the can down the road and drawing out the process with disputes.

“I would much rather see someone go to a free housing counselor within their community or state to get the assistance to fix their credit so it’s truly fixed, and not just a Band-Aid,” she said.


Pay Off Debt

Your debt can have a huge impact on your credit score – especially if everything is maxed out.

According to Dawn, about 30 percent of your credit score is determined by your credit history – and the formulas used to determine your score can get very specific.

“They’ll look at how much money you’ve been allowed to borrow, whether the terms for that amount are on an installment plan or whether they’re revolving, and then they’ll look at how much of that you’ve spent or owe back,” Dawn explained.

Credit bureaus typically follow the “30 percent rule” – meaning the goal is for consumers to have spent 30 percent or less of any credit they possess.

“Let’s say you have a credit card for $1,000, and it’s at $1,000 – that’s going to lower your credit score,” Dawn said. “But if you’ve spent 30 percent of that balance or less – so $300 or less on a $1,000 card – that will actually raise your score.”

And, if you have bills in collections, Dawn said that paying those off can have a significant positive impact on your score relatively quickly – and she encourages clients to keep proof of payment on those collections.

“If you pay off a collections bill that was reported by two of the three credit bureaus,” Dawn explained. “But the payment is only reported by one bureau. Unfortunately, it’s on you to go to the other bureau and make sure they show the payment – that’s why I tell my clients to always, always keep a paper trail.”

Young, first-time homebuyers should also consider how student loan debt can impact their credit score.

“A lot of young people think that, if their student loans are in deferment, the thought is because they don’t need to make payments, that those payments don’t get counted as a monthly debt charged against them,” Dawn said. “But that’s not true when you’re talking about a mortgage. In qualifying for a mortgage, there’s a formula we’re federally required to use to calculate a monthly debt, and those payments get counted.”

Dawn said she always encourages young people to avoid taking out more student loans than absolutely necessary.

“In ten years or so, it’s predicted that people will owe more on student loans than on a mortgage,” she said. “Already, these students are coming out of school with one arm tied behind their back. They have $85,000 in student loans but can only get a job that makes $50,000 a year – it’s a hole or a pit that’s very hard to dig yourself out of.”


Limit Credit Inquiries

Once you’ve worked out a plan to pay down your debt, the next step on the path to repairing your credit is to limit hard pulls on your credit. While monitoring your credit score through an app or service will not affect your credit, applying for a credit card, a personal loan, an auto loan, or other can negatively impact your credit if done too frequently.

“Thankfully, there is a little wiggle room,” Dawn shared. “Three hard pulls from the same industry within 90 days of each other will not ding your credit. So I’m shopping around for a mortgage and submit one or two loan applications? That won’t affect my credit.”

However, Dawn still urges caution and encourages clients to avoid or limit hard inquiries whenever possible.

“For example, I had a client who went to buy a car, and the dealership pulled her credit 27 times in a single day as the financing manager attempted to secure the payment she requested,” she shared. “They were all hard credit pulls, and it just drove her score down.”

Instead, if you have to purchase a car while working to improve your credit, Dawn recommends telling the dealership to only do one or two hard pulls on your credit. You can also try to finance an auto loan through your local bank, which should only pull your credit score once.

You should also carefully weigh the decision to open a new credit card or to shop around for personal loans.

“So, if it’s Christmastime and there’s a deal to get 20 percent off if you open a credit card, but you’re in the process of buying a home or are working through repairing your credit, I’d be cautious of doing that,” Dawn explained. “And it can be tempting to go from institution to institution to try and find someone who will say yes to giving you a loan – whether a mortgage or a personal loan – but I really caution against that. It can really drive your score down, be counterproductive in the long run, and become an obstacle to you gaining better financial stability moving forward.”

“I understand the desperation of that situation,” she added. “But the truth is that the guidelines are the guidelines – whether I’m a bank or a credit union or a fintech or a broker. Federal guidelines are federal guidelines, and for mortgages, we can’t break them.”


Don’t Give Up

But no matter what your credit looks like, don’t give up – even if you are in or recovering from bankruptcy.

“Having a bankruptcy doesn’t keep you from buying a home,” Dawn said. “You can get a mortgage 2-4 years after bankruptcy if you get your credit back on track.”

“You can read a lot in a credit report,” she added. “If you had good credit for most of your history, but it suddenly dips, sometimes exceptions can be made. If I see that, I try to ask clients – did someone get sick, did they get laid off? What happened in their life to cause such a sharp decrease.”

Regardless of your circumstance or credit score, the most important thing, Dawn said, is to not give up. And, if you need help building your strategy, why not try chatting with your attentive local banker? Our welcoming bankers can help you create a plan that works with your life and situation that will set you up for success.


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