Finding your dream home can lift your spirits and make your day. When you go to apply for a mortgage for that home, however, it may produce some shock, especially if you have a considerable amount of debt. Certain types of debt will affect your ability to get a loan more than others. Here is a look at different types of debt and how they can affect your ability to get a loan.
Your Credit Score Is the Key Factor
Going to a lender and applying for a loan means that the lender will most likely take a look at your credit score. The lender will very likely base the decision on whether you get a loan or not largely on that one statistic. Other factors will include the amount of your debt and your income.
Your credit score will reveal your total indebtedness and the type of loans that you have. They will also consider how long you have had the debt and whether or not you have applied recently for new credit.
Lenders look for a certain amount of debt-to-income ratio to determine whether an individual should get a loan or not – particularly when applying for a mortgage. The ratio is usually between 38 to 45 percent of your income each month. The different types of debt will affect your credit score in the following ways.
This type of credit is often credit card debt and school debt. Since there is no collateral on this type of debt, it can hurt your ability to get a loan, particularly if you have not been keeping up with your payments. Keeping up with your payments will raise your credit score, and it also makes you look good if you have been faithfully paying on-time over many years.
Unsecured credit may also hurt your credit score, no matter how regularly you have paid on time because it is calculated in with your debt-to-income ratio. Lenders know that people with a ratio too high are likely to run into trouble paying off their debt at some point. When the ratio is too high, it is not likely that you will be buying a new house anytime soon.
Lenders are particularly interested in your secured debt. This is because it can be reclaimed by the lender if you should default. They know that secured debt makes you more likely to repay the debt because you will want to hold on to the property.
Having an existing mortgage is secured debt and makes you look better to a lender. Having an auto loan that you are currently paying for is also secured credit. These types of loans demonstrate that another lender thought your credit to be good enough to give you a mortgage or car loan.
Type of Credit
If all of your debt is one type of credit, such as credit card debt, this will not look good to a lender. They prefer to see a balance of types, such as some unsecured credit, and some secured credit.
Having older credit will also help your credit score. It will only help, though, if you have a long record of paying on time, and have always been paying the minimum amount. If a lender sees that you have recently applied for a number of new credit cards, this is not a good sign because it will likely reveal that you have problems controlling your credit.
Borrowers have to look good to a lender in order to get a loan. This means you not only must have a good credit score, but that you also have a low debt-to-income ratio. Paying down your debt and raising your credit score will not only help you get a mortgage, but it will also help you get better terms, too, and more money.
Taking time to evaluate and raise your credit score – if needed – before applying for a mortgage is worth the effort, especially if it is lower than 740. Avoid getting new debt in the process, and be sure to pay your bills on time. Having a good credit score can lead to lenders gladly giving you that mortgage you wanted.