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Why Is It So Hard to Get a Debt Consolidation Loan If You Have a High Debt-To-Income Ratio?

If you pay multiple credit card bills each month, getting a debt consolidation loan can make sense. It will cut paperwork for you and can lower your annual interest rate, allowing you to devote more money toward paying the outstanding loan balance. It can be frustrating, though, to discover that even if you are paying your bills on time, a high debt-to-income ratio can make you risky to lenders and they may balk at giving you a loan.

  1. Basics

    • Credit cards are unsecured loans, meaning there is no collateral backing them. If a borrower fails to repay the loan, the lender has little recourse. Credit cards charge higher interest rates to ensure that, even if some of the customers fail to repay, those who do will keep the lender profitable. Secured debt are loans with collateral. If the borrower fails to repay, there is an asset that the lender can seize to secure repayment. People seeking debt consolidation loans to lower their interest rates will usually have to post some sort of collateral. For most people, their largest asset is their house, and the house can serve as collateral for a debt consolidation loan. In practice, debt consolidation loans in which the a house is used as collateral are home equity loans. Other assets may also serve as collateral. While unsecured debt consolidation loans are possible, they are riskier for the lender and will probably carry a higher interest rate and finance fees.

    Significance

    • Debt-to-income ratio is a key indicator of a person's ability to repay a loan. It is, simply put, the share of a person's monthly income that goes toward debts. Banks and investors use variations of this ratio when making decisions about whether to lend money. It is a prime component of the Fair Isaac Corporation's credit score, also known as the FICO score. If more than 40 percent of your monthly income goes toward debt, then financial difficulties and even bankruptcy are a possibility in your future, according to U.S. News and World Reports.

    Considerations

    • The debt-to-income ratio formula is simple. There are really two ways to improve your score: make more money, or pay off so enough debt that it lowers your monthly payment. If you have a high debt-to-income ratio, consider using your entire tax return check to pay down debt. Consider getting a second job.

    Prevention

    • If your income remains the same, taking on new debt will increase your debt-to-income ratio. If you are considering applying for a debt consolidation loan, or even a new mortgage, consider the effect the new debt will have on your monthly cash flow. The University of Idaho recommends keeping your monthly payments for debts --- other than your mortgage --- below 15% of your after-tax take-home pay. This includes your credit cards, student loans, child support, alimony and vehicle loans.

    Warning

    • Some debt consolidation firms are designed to prey on the weak and disadvantaged. Because debt consolidation loans often require collateral, working with these groups can put a homeowner's house at risk of foreclosure. If you have a high debt-to-income ratio and a lender seems too eager to lend to you or advises you to falsify your income on a loan application, beware. Even those who do not own their homes may be subject to scams if they are seeking debt consolidation loans. The City of Seattle's Information Security Newsletter warns that "unsecured debt consolidation loans" is a common subject for spam email. An unsecured loan is loan in which no collateral is pledged.

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