Should You Pay Down Debt to Help Qualify?
Most loans today employ the use of calculated debt to income ratios. A debt ratio compares outstanding monthly payments with gross monthly income. If someone has $3,000 in monthly debt and the maximum limit is $10,000, then the ratio is 30. If a mortgage program asks for a maximum 33, then this mortgage application would qualify. Typically there are two such “ratios” and they’re referred to as the ‘front’ and ‘back’ ratio. The front ratio is assigned to the mortgage payment while the back ratio takes into consideration the mortgage payment, along with taxes, insurance and mortgage insurance when needed, and other revolving and installment debt. Revolving debt is like a credit card while installment debt is typically associated with a car payment.
Yet as it relates to debt ratios, sometimes while the front ratio might be in line, additional consumer debt might just put the qualifying out of reach. This means too much installment debt or revolving debt. Most programs today allow you to pay down outstanding credit to help qualify. But there are differences between the types of credit.
With installment debt, one needs to pay down the current debt with a lump sum payment. The monthly payment may still be the same after a paydown, and it usually is, so that’s why to help qualify with an outstanding installment loan it may be necessary to pay off the debt entirely. Many times, this is too big of a challenge. Not everyone will have enough cash on hand to accomplish this.
Yes, one can borrow from someone else but when that happens the lender will want to know where the payoff funds came from and then calculate monthly payments independently. But, paying off installment debt will lower ratios hopefully to a qualifying level.
Revolving debt is a bit different than installment debt, but paying down a revolving account can help a little more. Paying down a revolving debt will lower the monthly payment and result in lower ratios. This can be a strategy and is allowable in most instances. However, it’s not unheard of for a lender to ask someone to close the account in its entirety. Why? Because the lender knows the borrower can go right back out the day after closing and run up those accounts once again.
If you’re not sure about your qualifications, speak to your loan officer who can guide you through the process.