How To Consolidate Debt With A High Debt To Income Ratio – Forbes Advisor
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One axiom of personal finance is that the only people who can borrow money are those who don’t need money. The irony of this established truth particularly hits those who have amassed so much debt that they cannot use a consolidation loan for relief.
However, there are ways you can consolidate debt even when you have a heavy debt load as measured by your debt-to-income ratio.
Determining Your Debt-Income Ratio
The Debt-Income Ratio (DTI) is an important measure of personal finance. It shows the ratio of your monthly debt payments to your monthly income. It is expressed as a percentage.
Lenders use DTI to make credit decisions. A lower DTI tells them that a borrower is less risky. This can affect interest rates and other loan terms, as well as whether an application is even approved.
To calculate your DTI, add up all of your monthly debt payments. Include credit cards, as well as auto, student, personal, and other loans. Include child support or child support that you have an obligation to provide. Rent, insurance, gasoline, groceries, utilities, and other non-debt expenses are not included.
Now add up your total monthly income. Take into account salary, interest, and dividends. Lenders vary, but the inclusion of child support and child support payments is generally optional.
Next, divide the total monthly debt payments by the total monthly income. Multiply the resulting decimal number by 100 to get your DTI as a percentage.
This is how debt consolidation works
Debt consolidation loans provide money to pay off other loans. Why borrow money to pay off your debts? Several reasons:
- With a debt consolidation loan, you can extend the time you have to pay off your debts. This allows you to make smaller payments. This can reduce the stress of the monthly closing meeting, among other benefits.
- You can get a lower interest rate on a debt consolidation loan. Lower interest rates can also mean lower payments and less stress. This is especially true if your existing debts include credit cards. This is even more true if you missed a payment with one or more credit cards. Card issuers often add penalty interest of up to 30% to late payers.
- Having all of your debts together into a single one makes recording, billing, and budgeting easy. It’s easier to keep track of a single payment than it is to make multiple payments. This can reduce your chances of missing payments and incurring late fees and interest penalties. Paying on time also helps your credit score.
- You can use a consolidation loan to pay off debts faster. Although the consolidation loan is likely to have a longer term than your existing debt, lower interest rates and fewer fees could save you enough to make additional payments on your debt.
Consolidation loans work best when you have good credit history, enough income to easily make the consolidated payment, and an obligation to pay off your debts. They don’t work so well when you have a high debt to income ratio. However, there are again ways to get around this.
How a high DTI affects debt consolidation
Mortgage lenders generally offer the best terms to borrowers with a DTI below 43%. You can still take out a mortgage at up to 50% DTI, but the interest and other costs will likely be higher.
Unsecured debt consolidation personal loans have stricter DTI limits. Generally, a DTI of 36% or less is required to get the best interest rates and other terms. Many lenders do not lend to borrowers whose DTIs are above 43%.
Even if approved, a high DTI borrower may have to pay more interest on a debt consolidation loan than the loans that are being consolidated. This can make a debt consolidation loan a much less attractive tool for managing debt.
High DTI Debt Consolidation Options
Is there any way to get a debt consolidation loan with a high DTI? In fact, there are several options including:
- Get a co-signer. If you have a friend or family member with good credit and low DTI and you guarantee your loan by signing it, you can get an unsecured debt consolidation loan with a reasonable interest rate and favorable terms. The potential downside is that if you don’t make payments on time, you can damage your relationship with the co-signer. So this only applies to borrowers with sufficient incomes who are determined to pay off their debts.
- Get a secured loan. It is important to know the difference between secured and unsecured debt. Most debt consolidation loans are unsecured, which means that you have not posted any collateral that the lender can seize if you fail to make the payments. However, you can get a secured personal loan on affordable terms when you have collateral such as a car or other asset. This makes you a lower risk borrower from the lender’s perspective. However, you run the additional risk of losing the asset you have deposited as collateral.
- Use a home loan. A home equity loan or home equity line of credit uses the equity in your home as collateral. Home loan terms can be attractive. Again, however, you run an additional risk. If so, you run the risk of losing your home.
- Do a cash out refinance. Another way to develop home equity is to refinance your mortgage with a loan in excess of the amount needed to pay off your existing mortgage. The excess money can pay off other debts. The low interest rate and easy refinancing conditions can be tempting. However, like with a home equity loan, if you fail to make payments on your new mortgage, you risk losing your home.
- Transfer of credit card balance. Credit card issuers are constantly offering low-interest and even zero-interest introductory credit transfer card offers for borrowers applying for new cards. If you have good credit and your DTI isn’t too high, you may be able to purchase one of these cards and then transfer the balance from high yield credit cards to the new one. This can save a bunch of interests. However, if you do not settle the balance on the new card by the end of the introductory tariff period, you could be overwhelmed with interest charges anyway.
Lower your DTI
The least risky way to use a debt consolidation loan to pay off your debts when you have a high DTI is also the most time consuming. That is, to lower your DTI before taking out the loan. That’s how it’s done:
- Pay off your debt. It’s a classic catch-22, that’s right. But to the extent that you can pay off some of your debt, you improve your DTI. Perhaps you could sell a mostly paid for car, use the proceeds to pay the car bills, and pay cash for a cheaper ride. Another option: get a loan or even a gift from a friend or family member and settle one or more of your debts. Otherwise, you can try eliminating unnecessary spending to free up cash and then using the classic debt snowball or debt avalanche techniques.
- Earn More Income. You can play with the other side of the DTI equation by increasing your income. Take on a second job. Ask about a raise. Move to a new position that pays more. Do overtime. All of them can increase your income and improve your DTI.
Alternatives to Debt Consolidation
If you just can’t get a debt consolidation loan no matter how hard you look, there are still alternatives. Here are a few options you might consider:
- Get credit counseling. Working with a credit advisor to create a budget and manage the expenses is a smart move no matter how you’re reducing your debt. The best choices for credit counseling are members of the Financial Counseling Association of America or the National Foundation for Credit Counseling.
- Sign up for a debt management plan. This requires a contract with a company that will first work with your lenders to lower interest rates and waive default interest and other penalties. Then, you transfer a single monthly payment to the debt management company that pays for your loans. Debt management plans also involve fees and require a commitment on your part to pay off your debts.
- Declare bankruptcy. If you don’t see a way to ever pay off your debt, applying for protection under Chapter 7 of the Federal Bankruptcy Act may involve selling some of your personal belongings, but ending most of the claims. Submitting after Chapter 13 will give you more time but still require you to pay off your debts. Both approaches do long-term damage to your creditworthiness.
- Try debt settlement. For a fee, debt settlement companies will try to convince your creditors to accept less than you owe in exchange for a lump sum. However, the fees can be up to 35% of the amount owed. And unfortunately, many debt settlement offerings are downright scams, making this a last resort.
18% to 25%
On the secure website of Nationaldebtrelief.com
Getting a debt consolidation loan with a high DTI is not easy, but it is doable. It can cost more and take longer, but there are ways to deal with a high DTI. And if you think long-term and work to control your spending and maximize your income, you can potentially reduce your DTI and be a more attractive borrower – or even pay it off without a debt consolidation loan.
frequently asked Questions
What are front-end and back-end DTIs?
Some mortgage lenders use a front-end DTI, or Housing Quota, which only includes the mortgage payment, mortgage insurance, and other housing expenses. Back-end DTI includes mortgage debt plus credit cards, car loans, student loans, and other debts.
Will a Debt Consolidation Loan Help My DTI Rate?
Usually, yes, by reducing your monthly debt payments.
Will Debt Consolidation Damage My Credit Score?
Using a debt consolidation loan to pay off your debts can temporarily lower your credit score. However, if you reduce debt and stay tuned with payments at the same time, you can improve your score in the long run.