The type of debts you carry can mean the difference between getting an approval on your loan or not. Even if you only hold one debt but its terms hold significant weight on your overall finances, you may end up getting denied on your application.
Before you step into the loan acquisition process, it’s important to know how a type of debt can impact your potential approval.
First, know that there are two types of debt:
(a) secured debt – these are loans that are backed by a collateral. Collaterals are properties that serve as a guarantee of security should you default on your loan payments. The most common collaterals are vehicles and real estate properties which have significant market value. If you fail to meet your payments, the lenders have the right to take these guarantees in exchange for the money you were not able to return.
(b) unsecured debt – these are loans that are not backed by a collateral. Unsecured loans are usually lent to borrowers who are determined to be good risks. That is, they were able to show that they are financially stable and therefore capable of taking the burden of the loan and repaying it to its full term.
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A question of risk
The thing is, lenders are not really picky as to what debt a borrower carries. A secured loan is not favored over the other, but they do care about how you spread your risk.
For example, in the case of credit cards which are unsecured loans, it will give the lender an impression of a continuous stream of credit responsibility. One or two may seem fine but too many credit card debts may pose the question of payment capacity. (Hence why your DTI ratio matters as well!) Can you pay these balances in full? Can you carry the burden of revolving credit and accruing interest?
A secured loan such as an auto debt – which is a significant debt – may still be favorable, but as long as you show as a consistent history of paying them on time, you shouldn’t have a problem.
How about a mortgage?
A debt as large as a home loan may play a large part on your DTI ratio which means if you get approved with the current loan and it will exceed the ideal DTI ratio limit, you may have a hard time paying it back.
How you pay your mortgage also reflects on your score so your lender shouldn’t have a hard time recognizing your repayment capacity. If you are able to show good history, backed by stable income sources, qualifying for an additional loan may not be much of a difficulty.
However, if you are taking another mortgage, expect lenders to probe you more about your current home loan. Are you refinancing? Getting a reverse mortgage? Selling your current home and using the proceeds to get the new loan?
And of course, the type of loan that you are courting, per se, is also a major determining factor in getting an approval. Prime lenders usually have stricter requirements and are therefore less inclined to give out loans to those who carry a suspicious number of debts, especially those in the subprime levels.
Meanwhile, there are a growing number of lenders who are all too willing to give you the money despite your risk, regardless of the debts you carry.
When applying, be honest to yourself and recognize your own risk as a borrower. Finding the right lender matters as much as getting the needed money.