Bankruptcy Law Blog

Tuesday, May 31, 2016

The Affect of Loans on Credit Ratings

How do loans affect your credit rating?

In understanding how your loans affect your credit rating, it is important to grasp the differences among various types of debt. Almost everyone in our society lives with some debt. Typically, even very wealthy people purposely carry some debt because they understand the value of being creditworthy and the financial advantages of paying off some things over a prolonged period of time. The rest of us usually become aware early in our lives that our credit rating will affect us when we attempt to make significant purchases, such as a car or a home, and that it is in our own best interests to maintain a good credit score.             

Types of Debt

Debt is characterized into two primary types: secured and unsecured.

Secured debt is debt which is anchored by collateral. If you owe money in the form of a mortgage, for example, if you do not keep up with your mortgage payments, the bank that holds your mortgage can eventually foreclose on your property. Similarly, if you take out a loan to buy a car, and then fail to keep up your payments, the bank lending you the money can repossess the automobile.

Unsecured Debt is debt that is not backed up by anything. Credit card debt and student loans fall into this category. If you don't pay your Visa or MasterCard bill, the companies you owe have nothing substantial to reclaim. Clearly, they would be hard-pressed to assign a monetary value to clothes you have worn, books you have read, or gifts you have given away. In the same way, the bank that lends you money for your college education would find it impossible to reclaim whatever knowledge you've already learned.

How Consumer Loans Affect Your Credit Score

Most legitimate loans (as opposed to loans from bookies and loan sharks!) can either help or hurt your credit score depending on how you manage them. Assuming you do not overspend or over-borrow and that your income allows you to make satisfactory payments on your loans according to a fixed schedule, paying off loans is something that can improve your credit rating.

Student loans

Though student loans are unsecured, this doesn't mean they are bad for your credit score. As long as you pay your bills on time, the fact that student loans take so long to pay off can work in your favor, giving you a lengthy track record of timely repayments. Nonetheless, if your student loans reach a very high level (as you complete, for example, medical school or law school), you may be deemed a poor candidate for a mortgage because you have too low a ratio of income to debt.

Car Loans

In general, because car loans are secured by the automobile itself, banks may look favorably upon the fact that they show you carry diversified types of debt. Also, since car loans may be more difficult to obtain than credit cards, lenders may be positively impressed that you have been approved for a car loan, assuming that you have already been vetted by the car company as a reasonable risk.

Payday loans

In most cases, payday loans do not appear on your credit report, often because they are very short-term. This is a good thing, because company heads usually charge exorbitant interest rates. Workers are (or should be!) well aware that defaulting on a payday loan may not only damage their credit, but is very likely to result in the termination of their employment. Payday loans are typically taken only when workers are desperate and are most often paid back as quickly as possible.

Mortgage Loans

Getting a mortgage is a fairly complicated process because, even though the bank holding the mortgage, is capable of foreclosing if you are irresponsible in your payments, they don't really want to foreclose -- they would much rather have you pay your rent and taxes in a timely fashion. Missed payments on any previous mortgage will lower your credit ratings, demonstrating to wary lenders that you have had trouble keeping up with your most basic expenses. Certainly, if you are looking for a second mortgage or equity loan, the new lender will be carefully scrutinizing the ratio of your income to your present and past debt as well as to your requested loan.

If you live in Alabama and are having trouble meeting mortgage or other loan payments, are being harassed by creditors, or are facing garnished wages or foreclosure, the smartest thing you can do is contact an experienced personal bankruptcy attorney to clarify your options and help you navigate the tricky waters of rising debt.

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