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Debt Consolidation HELOC
By Gina PogolMortgage Credit Problems Columnist
While an ideal
solution to having too much high interest debt is to pay it all off with a
cash-out refinance or second mortgage, it is getting more difficult to do that
these days. Home prices are declining in many areas, and lenders are scaling
back the percentage of a home's value they are willing to lend on. Tightening
guidelines also means that underwriters won't look too kindly on applicants
with high monthly payments in relation to their incomes. So how do you get
around this?
Debt-to-Income Ratios
Are Key
Debt to income ratios show the amount of debt you pay in
relation to your gross monthly income. There are two ratios: your top, or
front-end ratio, and your bottom, or back-end ratio. The front-end ratio equals
your monthly house payment, including principal, interest, taxes, and
insurance, divided by your gross monthly income. It shouldn't be much more than
28%. Your back-end ratio is all of your debts, including your housing expenses
and the minimum payments on your credit cards, your car payment, and other
payments, divided by your gross monthly income. That shouldn't be much more
than 41%.
So, what do you do if your excess debt is the reason you
can't get a loan to pay off your excess debt?! Fortunately, there is a way out
of this catch-22 situation.
Pay Off Debt to
Qualify for Your Mortgage
Some lenders will allow you to do what is called
"paying off debt to qualify" for your new loan. This means that they
will subtract the monthly payments of the debts you'll be paying off with your
new loan -- and not count them in your debt-to-income ratios. The lower ratios
should make it easier for you to get approved. Of course, you actually have to
pay off the balances and close the accounts. To make sure this is done the
closing agent will cut checks to your creditors and send them when your loan
closes.
Which Debts Should
You Pay?
Ideally, you'll have enough home equity to pay all the
high-interest debt off and replace it with lower-interest home equity debt. The
next best thing is to pay off the debts with the highest APRs, then tackle the
less expensive loans. However, you may have to prioritize debts to be paid by
payment / balance in order to be approved for your loan. This method gives you
the greatest payment reduction for the amount borrowed.
List each debt, the minimum payment, and the outstanding
balance. Divide each balance by the payment. Start with the lowest balance /
payment and work your way up. Here's an example of a list of debts you might
want to pay off:
Description Balance Payment Balance / Payment
Car Loan 4000 400 10
Credit Card 1 13500 175 77
Computer Loan 1000 10 100
Credit Card 2 2000 30 67
Credit Card 3 2500 17 147
Credit Card 4 1500 200 8
If you can only borrow $20,000 but have $30,000 in debt,
like this example, use your debt consolidation loan to pay off these first,
then tackle the other ones.
Credit Card 4 1500 200 8
Car Loan 4000 400 10
Credit Card 2 2000 30 67
Credit Card 1 13500 175 77
Paying these first removes $805 per month from your debt
ratio. Paying them in the wrong order would only reduce your debt ratio by $432
a month, and you'd have a $20,000 second mortgage either way.
About the Author
Gina Pogol writes for
an online media company, specializing in mortgage and finance issues. She has a
BS in Financial Management from the University of Nevada and was formerly a
systems consultant with Experian and a loan officer with Centex.
About the Author
Gina Pogol works as a writer and editor for an online media company. She has a BS in financial management, was formerly a business credit systems consultant with Experian and a mortgage loan consultant.
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