High Debt To Income Ratio and Consolidation Loans

A debt consolidation loan can be very helpful for those who have many outstanding debts owing to several different lenders. It allows someone to focus on one monthly payment, often at a more favorable interest rate, instead of various payments. Lending institutions use a number of metrics to determine who is eligible for a consolidation loan and who is not. One of the most important metrics is income to debt ratio. A high income to debt ratio can make it difficult to secure a consolidation loan, but not impossible. Let us explore the options available for those with a high income to debt ratio who are seeking a consolidation loan.

We will begin first by outlining what is a consolidation loan and why it can be beneficial. We will then discuss income to debt ratio, its impact on securing a consolidation loan, and finally options for those with a high income to debt ratio who are looking to consolidate their loans.

Best Personal loans for Debt Consolidation

What Is A Debt Consolidation Loan

Debt consolidation is a process undertaken by an individual who has several unsecured debts in an effort to make payment easier and possibly reduce the interest paid across all debts. This is achieved by securing a loan from a bank or lending institution which is used to pay off the outstanding balance on all debts. The borrower then only has the one large loan to pay per month.

Let us use an example to make this more clear. Take James who owes $20,000 to 5 different lenders. These can be anything from credit card companies, a car loan, and a few personal loans from different banks. With a $20,000 consolidation loan, James would be able to pay all five creditors. By doing this James now only has one payment to make per month.

What Are The Benefits Of A Debt Consolidation Loan

As stated above, the main benefit of a debt consolidation loan is the ease of only having to organize and make one monthly payment instead of many. Another major benefit is the ability to pay off the loan over a term that allows for more financial comfort. Take the previously outlined example of James who owes $20,000 to five different creditors. The total sum of the monthly payments to all five may be difficult to make along with paying other monthly expenses like rent, food, utilities, etc.

Let’s say that the monthly payments for James totals $700 per month. James has had a difficult time making all the payments as he simply does not have $700 after all other expenses. With a debt consolidation loan, James can increase the amount of time needed to pay off the loan allowing him to reduce the size of the payments. James cannot afford to pay $700 per month, but perhaps he can afford to reliably pay $450 per month.

Income To Debt Ratio

Debt To Income ratio is one of the most important aspects lenders look at when determining whether or not an individual qualifies for a loan or not. The reason why it is so important to lenders is because it tells them whether or not one can take on another debt or not. Even if credit and payment history is good, a very high income to debt ratio would imply that there is simply not enough financial resources to take on another loan.

Calculating income to debt ratio is simple and straightforward. All monthly payments are added up and divided by the person’s gross monthly income. If one’s total monthly debts add up to $2000 and their monthly gross income is $5000, then their income to debt ratio is 40% because 2000/5000 = 0.4.

A great deal of study and research has gone into assessing who to give a loan to. The research has found that people with a higher income to debt ratio, on average, have a more difficult time meeting their payment obligations. This should not be surprising, the larger the percentage of one’s income is applied to paying off debts the less money they will have available to take on and pay new debts.

High Debt To Income Ratio and Consolidation Loans

Most lenders do not like to lend to people with a debt to income ratio (DTI) higher than 43%. Mountains of research have been conducted on the subject and 43% has become the industry standard cut off. Lenders may be more favorable to those with a poor credit score, something under 650, but with a low income to debt ratio over those who have good credit but a high income to debt ratio.

It is clear that reducing one’s debt to income ratio is imperative for those whose DTI ratio is too high and thus prohibiting them from securing a consolidation loan. There are some basic changes one can make to reduce their ratio.

  • Temporarily Increase DTI
    It may be the case that increasing one’s DTI in the short term will lower their DTI in the long term. Paying down debts in a short period will allow one to devote less of their income to paying debts, later on, effectively lowering their DTI.
  • Focus Payments on Loans With the highest Interest
    Some debts carry higher interest rates than others. The debts with the highest interest rates have the greatest impact on one’s DTI because so much of a payment is going to interest instead of the principle. Focusing on these debts and paying them down results in lower interest charged which will require less money per month.
  • Increasing Income
    It may be the case that a little bit of sacrifice will be necessary to qualify for a consolidation loan. While not everyone can get a raise, most people can take on a part-time job. Even if it is only for a few months. All the money gained from a part-time job can be devoted to paying the largest debts with the highest interest.
  • Transfer Balance of High-Interest Credit Cards
    Most credit card companies offer promotions that charge no interest on transferred credit balances for 6 months. This can be a great strategy, especially if extra income has been secured. Transferring the balance to a card that offers no interest for the first 6 months can offer a serious advantage in paying the debt down.

Income to Debt ratio is a critical aspect to consider when applying for a consolidation loan. It is advised that those who have a high debt to income ratio be vigilant in reducing their ratio as it could prove prohibitive to securing a consolidation loan.

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