Just like there are good and bad fats, there are also good and bad debts.
Both good and bad debt can affect your mortgage approval, which can be disheartening to find out during your application process. Get educated on types of debt here, but we can’t help with your fat situation 🤷♀️.
Types of debt
Most debt can be categorized into these four types of debt: secured, unsecured, revolving and installment.
- Secured debt requires collateral during the length of time you’re borrowing money. Secured credit cards, which are common for individuals looking to start or repair their credit, take an amount of money you deposit as your spending limit. Another example is an auto loan, where you pay the lender monthly for the car, while they still hold claim to the title of the car.
- As one would assume, unsecured debt works the opposite of secured. Instead of requiring a form of collateral, this type of debt operates on more of an honor system. This type of debt allows you to borrow freely from your predetermined, approved limit. However, you can’t cheat this honor system. Ditched payments will quickly catch up with you via collections and damage to your credit score.
- Revolving debt allows you to borrow as often as you’d like, up to the limit you are offered. Rather than just being given a single, lump sum of money that you pay back over time, revolving debt allows you to keep borrowing until you’ve reached (or lessened) your limit. The main example of this would include, just like secured or unsecured, a credit card, allowing you to use credit until the limit has been met.
- You take on installment debt when you borrow a lump sum that you pay off over time. So, rather than borrowing money as you pay off the debt, the initial debt must be settled before borrowing any further. Common examples of installment debt are car loans, student loans or mortgages.
What is bad debt?
Determining whether debt is bad versus good can often be subjective, depending on who you ask. This can rely on a case-to-case basis and taking a look at the bigger picture. However, there are strong indicators that can help you determine it for yourself.
- Purchasing an item that loses value immediately
- Opting in for a longer term than average
- Has a high interest rate
- Classified as a payday loan
So there’s good debt?
Yes! Though just like with bad debt, it can be fairly subjective. But indicators of it being good debt will include:
- Purchase of an item/asset that gains value
- An investment toward your future
- Has a lower interest rate
- Selecting a term that allows you to payoff the loan as soon as possible
- Increases your net worth
What is included in debt-to-income ratios?
Understanding your debt-to-income (DTI) ratio is a crucial part of the homeownership process. The easy definition of a debt-to-income ratio is how much of your overall income goes toward the debt you owe. When applying for a mortgage, the lender will take your monthly debt and divide that by your gross income. NerdWallet agrees that most lenders like to see a DTI ratio of 36% or less.
Don’t be blindsided when applying for your mortgage. Know the types of debt that can have an impact on your mortgage approval to save yourself some heartache in the process. Movement has experienced loan officers to offer some pointers and direction on getting your ducks in a row before putting your application through the ringer.
Have further questions on how debt affects a mortgage application?