By: Virginia C. McGuire / Trulia.com
Want to get a new mortgage? Then your credit score is a really big deal — it can make or break your mortgage approval, and ultimately determine whether you get the house you want. But before we talk about credit scores, let’s talk about the debt that affects them.
There are two types of debt: 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’ll be able to recover the money it loaned you. Unsecured debt, on the other hand, means the bank can’t reclaim the thing you’re buying with the borrowed money. (Credit card debt is unsecured and so are student loans.)
Let’s look at the impact of four key consumer loans, a mix of secure and unsecured debt, on your credit score — and ultimately your mortgage-worthiness.
1. 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. 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 they might affect your ability to afford a mortgage.
2. 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.
3. 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. Payday loans are unsecured — the lender doesn’t have any collateral — and the interest rates are often exorbitant.
4. 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. Missed payments on previous mortgages will make your new lender very nervous, however.
If you already have a mortgage and are applying for another one, the new lender will want to know that you can afford to pay both bills every month, so it’ll be looking closely at your debt-to-income ratio. If your second mortgage is for a rental property, you may be expecting 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 have to qualify for any mortgages using documented income from other sources.
In general, having different types of debt can boost your credit score. It’s not necessarily a bad thing to have a student loan and an auto loan when you’re applying for a mortgage. But be careful — over-borrowing can hurt you. Most mortgage companies, in addition to looking at your overall credit score, will look for a debt-to-income ratio below 43%. They’ll look at all the money you owe and the monthly payments on all of that debt. They want to see that your income is enough to cover all your debts, including the new mortgage you’re applying for.