Different Types of Debt and How They Affect Mortgage Approval
Monday Dec 11th, 2023
Debt helps determine the borrowers’ creditworthiness and commitment to their financial obligations. Understanding the different types of debt and how they affect mortgage approval helps potential homebuyers take the necessary steps to get higher chances of securing a mortgage. Moreover, recognizing the factors when evaluating a borrower’s debt-to-income ratio will help individuals meet the criteria before applying for a mortgage.
1. Credit Card
High credit card debt negatively impacts your mortgage approval. Lenders usually focus on your total credit card balance to determine your monthly payment. Your credit utilization rate may still be affected even if you have a high credit card balance and pay your monthly payments on time. That’s why using 75 per cent or more of your credit limit is discouraged. Likewise, paying only the minimum amount due on your credit card debt can lower your credit score because it has minimal impact on your balance.
2. Mortgage and Home Equity
If you’re applying for another mortgage, lenders will determine your debt service ratios to ensure subsequent mortgage payments are affordable. A mortgage may be your largest debt; however, it may factor less than other debts. What you may not know is a home equity line of credit (HELOC) is treated like a mortgage when assessing debt.
3. Child & Spousal Support
Child or spousal support is part of your debt-to-income ratio. However, a percentage is added to your income if you receive a child or spousal support.
4. Student Loan
Lenders assess the monthly payments you make towards your student loan to determine your debt-to-income ratio. But unlike other debts, student loans are more flexible and usually have lower interest rates.
5. Car Loan
A car loan adds to your overall debt load. Thus, it can affect your mortgage application. Getting a mortgage can be financially challenging if your car loan payments are high.
6. Federal Debt
Before applying for a mortgage, lenders may require individuals to clear any outstanding federal debt, such as tax liens or unpaid federal student loans.
How Does Debt Affect Your Mortgage Approval?
If you’re buying a home anytime soon, you must put things in order. Aside from saving money and checking your credit score, don’t forget to determine how your existing debt can affect your mortgage.
Helps Lenders Determine Your Credit Worthiness
Don’t be discouraged if you have debt on your credit report. Your credit history helps lenders determine how you manage and prioritize your debt. For example, successfully repaying your student loan boosts your creditworthiness. On the other hand, if you don’t own a credit card or have any other debts, lenders may be hesitant as they have no idea about your spending and debt management habits.
Too Much Debt Impacts Your Mortgage Approval
When applying for a mortgage, lenders will assess your debt-to-income ratio. The thing is, too much debt increases your credit utilization and lowers your credit score. You are a risky borrower if your debt-to-income ratio is almost 50%. However, consistently making timely payments and having a high credit score make it much easier to get a mortgage.
Managing Your Debt Improves Your Credit Score
A higher credit score can help you get a lower mortgage interest rate. It’s always a good idea to try and boost your credit score before applying for a mortgage to increase your chances of success. Furthermore, making your minimum payments on time can boost your credit score with minimal effort.
Paying Off Your Debt
When paying off your debt, have a strategic plan in place. Assess your income and expenses to identify unnecessary expenses you can cut down on. If you’re having a hard time prioritizing your debts, consider these two strategies when paying off your debt:
- Debt Snowball Method – focus on paying off the smallest debt first and just paying the minimum for the other debts.
- Debt Avalanche Method – prioritize debt with the highest interest to help you save money on interest in the long run.
Understanding the different types of debt and how they can impact mortgage approval is crucial if you’re trying to secure a mortgage. Managing debt can increase your chances of getting the best mortgage rate and loan terms. Remember, a low debt-to-income ratio and a strong credit score are essential in mortgage approval!
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