When you apply for a mortgage, one of the first things a lender will look at is your credit score. To qualify for a conventional loan, you’ll need a score of at least 620. For an FHA loan, commonly used to help first-time homebuyers and people with credit issues, you must have a minimum score of 500.
But nearly all lenders will take a deeper look at your credit profile, especially at the debt you already carry. Whether it’s credit card debt or student loans, the type of debt you have can often make a difference.
How the kind of debt you have impacts your chances of approval
Mortgage lenders look carefully at the debt you already owe when evaluating you for a mortgage. In some ways, the debt all counts the same.
The most important example is through a metric called your debt-to-income ratio. This is a measurement of your monthly debt obligations as compared to the money you bring in. In most cases, you’ll need to keep this ratio at 43% or lower, according to the Consumer Financial Protection Bureau. The more overall debt you carry, the harder it will be to qualify for a mortgage.
And regardless of the type of debt, mortgage lenders also look at whether you have a history of making your payments on time. This boosts your credit score and gives lenders confidence that you’ll also pay your home loan in a timely manner. Your payment history is the biggest single factor in your credit score. The length of your credit history, or how long you’ve had your accounts, is another major factor.
That’s how debt can be your friend when applying for a mortgage: A long period of making on-time payments gives you a high credit score.
That said, mortgage lenders do take some unique items into consideration when it comes to different types of debt. Here are a few insights.
How you use credit cards tells a mortgage lender a lot about your financial life and the chances you’ll make good on a home loan. One unique factor when it comes to credit cards is the percentage of your total available credit you use.
That percentage contributes to a number called your credit utilization ratio. Say you have a $10,000 limit on your credit cards, and you owe $4,000. You then have a 40% credit utilization ratio. The credit utilization metric makes up 30% of your FICO Score, a leading credit score.
Similar to credit card debt, personal loans will also factor into that crucial debt-to-income ratio. Mortgage lenders will also evaluate your history of on-time payments on a personal loan. Be careful about when you apply for a personal loan, as well: A recent credit application can impact your ability to qualify.
If you use a personal loan to consolidate credit card debt at a lower interest rate, that could go a long way to reduce your monthly debt payments and boost your mortgage borrowing power.
If you’re not able to qualify for a personal loan, you’ll have a hard time getting a mortgage. Personal loans and mortgages have similar minimum credit score requirements. The minimum score for an FHA loan is 500, and it’s very hard to get a personal loan with a credit score lower than 550.
Student loans are a major reason why many college-educated Americans are postponing buying a house, but it’s still possible to buy a home with student loan debt. You might need to do some math first, though.
That’s because the way mortgage lenders view student debt is changing. For a long time, mortgage lenders counted 1% of your outstanding student loan balance when calculating your debt-to-income ratio. So if you owed $40,000, just $400 would be counted toward your monthly debt for these purposes, regardless of what you actually paid.
Now, mortgage lenders are more likely to look at your actual monthly payment. For conventional loans through Fannie Mae, the exact amount you pay each month goes into your debt-to-income ratio, even if your loans are deferred and you’re paying $0. Freddie Mac conventional loans will count 0.5% of the total balance if you’re not paying anything yet.
With an FHA loan, your actual monthly payment counts only if your payment plan will pay off your loan on time. Otherwise, the 1% rule still applies.
The bottom line
Debt can be very helpful when applying for a mortgage, or it can doom your chances. A long track record of prudently managing your credit cards, student loans and personal loans will let mortgage lenders know that you’re a good bet. But missing payments and maxing out your cards could keep you from qualifying for a mortgage.