HELOC for Debt Consolidation
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 has over a decade of mortgage lending experience, in addition to practice as a paralegal for a bankruptcy attorney, and as a business credit consultant for Experian. She is also certified to underwrite Fannie Mae loans. She earned her BS in Financial Management from the University of Nevada.
All information provided “as is” for informational purposes only, and is not financial advice. MortgageCreditProblems.com, its affiliates, and any of the independent providers of information on this site shall have no liability for any informational errors or incompleteness, or for any actions taken in reliance on information contained herein.
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