By Virginia C. McGuire | June 24, 2016
Different types of debt can boost your credit score — but overborrowing can hurt you.
When you’re shopping for a mortgage, your credit score is a really big deal; it can make or break your mortgage approval and ultimately determine whether you get that home for sale in Boca Raton, FL. But before you analyze your credit score, it’s important to look at how your existing debt affects that score.
Debt comes in two types: secured and unsecured. When you borrow money to buy a house, the bank can take back the house to recoup its money if you don’t pay the debt. That means the debt is secured — it’s balanced against something you want to keep and gives the bank some measure of security that it can recover the money it lent you. Unsecured debt, on the other hand, means the bank can’t reclaim what you’re buying with the borrowed money. (Credit card debt and student loans are unsecured.)
The following four key consumer loans affect your mortgage worthiness in different ways. Read on to find out what steps you can take to improve your credit if you have these loans (or are considering them), so you can qualify for the best mortgage rates out there.
- Student loans
Student loans are unsecured debt, but they’re not necessarily bad for your credit score if you pay your bills on time. Because they often take decades to pay off, student loans can actually help your score. Likewise, other loans held (and paid consistently) over a long period raise your score. Student loans will figure into your overall debt-to-income ratio, though, so a large student loan or other loan might affect your ability to qualify for (and afford!) a mortgage.
- Auto loans
Auto loans are secured debt, because the lender can repossess the car if you don’t pay up. In some cases, auto loans raise your credit score by diversifying the types of debt you carry. And because auto loans are harder to get than credit cards, some mortgage lenders may look favorably on you because you’ve already been approved for a loan that wasn’t a slam-dunk.
- Payday loans
Payday loans don’t usually show up on your credit report. But if you default on the loan, it could ding your credit. These loans are unsecured — the lender doesn’t have any collateral — and their interest rates are often exorbitant.
- Existing mortgage loans
Mortgages are the classic example of a secured debt, because the bank has the ultimate collateral — a piece of property. Mortgages, when paid on time, are great for your credit score. However, missed payments on previous mortgages will make your new lender nervous.
If you already have a mortgage and are applying for a second one, the new lender will want to be sure you can afford to pay both bills every month, so they will look closely at your debt-to-income ratio. If your second mortgage is for a rental property, you may expect the rental income to count toward the income side of the equation. However, most lenders won’t count rental income until you’ve been a landlord for two years. Until then, you’ll have to qualify for any additional mortgages by using documented income from other sources.
Article contributed by Trulia.
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