Congratulations on the purchase of your new home! You’re feeling great and ready to start making it your own. You decide to apply for a no-interest credit card to help fund your new décor to give yourself a little breathing room. But to your shock, you are denied. How could this be? How could you purchase a $500,000 home and not qualify for a $500 credit card?
Two Possible Reasons
First, when a new mortgage loan (or any loan) reports on the credit report, your credit score can drop due to the combination of a new loan and hard inquiry. After you make a few payments, your credit score will rebound, assuming you’ve haven’t submitted any other credit applications.
Secondly, a normal credit card is categorized as “unsecured” debt, and a mortgage loan is “secured” debt. A higher credit score is often required to obtain an “unsecured” line of credit – such as a credit card.
What is Unsecured Debt?
An unsecured debt is a debt that is not backed by collateral (personal property) to pay the debt if you default. For example, if you default on a mortgage or a car loan then your home or auto could be taken away. This is known as a repossession. If you fail to make your payment on an unsecured debt, creditors can only sue you for the amount owed and this usually results in a court judgment.
Common Types of Unsecured Debt
- Credit Cards
- Student Loans
- Utility Bills
- Medical Bills
What is Secured Debt?
A secured debt is a loan that is guaranteed by collateral – like your house or car. The collateral is considered an asset used to secure the loan. The lender can take it without suing you if you default on the loan. Because this debt is backed by collateral, lenders can offer better interest rates than they do with unsecured debt.
Common Types of Secured Debt
- Home mortgage loan
- Automobile loan
- Secured credit cards
- Pawn Shops
- Personal Loans
Your Risk is Greater with Secured Debt
Just because it’s easier to get approved for a secured loan doesn’t mean it’s less risky. In fact, for the borrower, secured debt is much riskier. If you put your home or car as collateral and you are not able to pay the bills, foreclosure and repossession are almost guaranteed. The lender will sell your house or car and keep enough of the proceeds to repay the unpaid debt balance and any legal costs. If the house or car sells for less than you owe, the lender can pursue a claim against you to try to recoup the difference. This is known as a deficiency judgment.
Working on Repairing Your Credit?
Life happens on its own schedule. If you’ve found yourself needing to consolidate and pay off debts and repair your credit, you might be feeling overwhelmed. The good news is there’s a strategy to expedite the process that can save you a lot of money and get your credit back on track in a matter of months.
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