Deciding you want to apply for a mortgage is a big step. You have to make sure your finances are in order and that a lender will look upon your loan application favorably. Many people focus on the credit score, figuring that is the factor that will make or break their deal. However, oftentimes it is not the score itself, but the types of debt you have that make or break your ability to secure a mortgage. You have to understand the two different types of debts you can have and how lenders look at them. This way you can better prepare yourself for a loan application and subsequent approval.
The Two Types of Debt
Generally, there are two types of loans you can carry – secured and unsecured:
- Secured – These loans are “secured” by something. In the case of a mortgage, it is secured by the house it helped you purchase. If you were to default on your mortgage long enough, the bank could take possession of the home. The same is true for a car loan – the bank can repossess your car if you don’t make your payments on time.
- Unsecured – These loans are not secured by anything. The lender provided the loan to you based on your financial background and ability to repay the loan. Personal and student loans are an example of unsecured loans. Another good example is credit cards – there is nothing for the bank to take back if you do not pay them because you did not put up any collateral.
Diversifying your Debt
Lenders don’t care too much one way or the other what type of debt you have, but they do want to see you diversifying some of your risk. For example, if all of your loans are credit cards, you have a lot of revolving debt. To a new lender, this means a continuous stream of available credit to you when you pay it off. This may make them nervous. On the other hand, if you have secured loans, such as a car or student loans and you pay them on time consistently, you not only increase your credit score, but you make the lender look at you more favorably. Between the different types of loans you can have, you should mix it up. Have a few secured loans while also mixing in some revolving debt, all why paying everything on time for the best results.
How Student Loans Affect Your Chances
Student loans seem to get a bad rap. This is especially true for those who seem “buried” in the loans they have. The fact of the matter is, these loans can greatly help your case as long as you pay them. If you have deferred loans just sitting there, they may not help. In fact, they probably hurt your chances because they may increase your debt ratio quite significantly depending on how the lender calculates your future minimum payment. If you have loans you currently make payments on, though, you can show your financial responsibility and ability to pay your debts on time.
How Car Loans Affect your Chances
Car loans are a secured loan. This makes banks much less nervous. However, car loans are not always easy to obtain. Just having an auto loan on your credit report is impressive to a prospective lender. It shows that you can secure financing despite the odds. Now, if you add to this fact the ability to pay your car payment on time every month, you may have an easier time securing a mortgage.
How a Mortgage Affects Your Chances
If you already have a mortgage reporting on your credit report, you can guarantee any new prospective lenders will take a close look at how you paid this loan. Mortgages generally have a much higher loan amount. If you have a history of paying your mortgages on time, a new lender may be willing to loan you new money. On the other hand, if your credit report is blemished with late mortgage payments, not only will your credit score suffer, new lenders will be leery about lending to you. What also matters is what you will do with this mortgage when you secure new financing. Are you paying off the current mortgage by selling your home or refinancing? Or are you trying to purchase a second home? If you will keep the first mortgage, it will affect your debt ratio quite a bit.
How Credit Cards Affect your Chances
Credit cards seem to be the loose cannon in the equation. Having a few credit cards can help your situation. It shows that you are able to hold a balance and hopefully, pay them on time. However, how much of your available balance you have outstanding could make a difference in your ability to secure approval. Lenders generally want to see you have no more than 20% of your available credit outstanding at any given time. This means you have to either pay off your balances as much as possible each month or you should not use your credit cards for any large purchases. The lower your utilization rate or the amount of debt you have outstanding, the better off you will be when you apply for a mortgage.
Before you apply for a new mortgage, it pays to take a close inventory of the debt you carry. Are you diversified enough that it does not look like you would be a great risk? Do you have your credit cards paid down enough that you still have quite a bit of available credit? Have you made all of your payments on time on any type of loan? These are all factors the lender will look at to determine if you are a good risk. This is all before they even look at your credit score. Even if you have a great score, you could find yourself scrambling to find a lender if you have late payments or are too heavy in one type of debt over another. Take the time to balance things out before applying for a loan in order to maximize your chances of approval.