How can I improve my income-to-debt ratio?

Unless you have a lot of cash on hand, you are going to need time to improve your ratios. Paying down credit cards instead of paying minimum payments, or making additional payments on your car or financed furniture and appliances is what may be needed. If you know that you are getting a salary increase shortly, time your loan application accordingly.

It is also important to know which debts to pay. Most underwriting, especially automated underwriting, will not consider debts that have less than ten months left to payoff. However, the normal tendency for people looking to pay off debts is to pay off those that have only a few months left on them. You would benefit more by making a double payment on a debt with eleven months to go — bringing it down to nine months — than paying a debt off completely with just a few months left.

Finally, sometimes there is another way to exceed the ratios. If you are refinancing your home and have a lot of equity (the difference between what you owe on your mortgage and the value of your property), a lender may give you a conditional approval. The approval may be conditioned on you paying down or paying off some existing debt. You may be able to borrow a little more money on your mortgage loan from your equity and pay down your debts to meet the condition.

Should I consolidate my debts?

Be careful of conditional acceptances. Some lenders are just trying to get you to borrow more money from them. If your debt ratios are good and you are current on your bills, you should question why this is necessary.

Some lenders will also try to get you to borrow more money to consolidate your bills. This may have nothing to do with credit or income-to-debt ratios.

You will be given monthly payment numbers showing that you can lower your interest rates and monthly payments by borrowing additional money on your mortgage to pay off your car, credit cards, student loans, etc. It is true that you will save money initially. However, many people find that within a short time, they have the same debt they had before they consolidated, in addition to a bigger monthly mortgage payment. Unless you are extremely disciplined or extremely desperate, stay away from consolidation loans.

From the Expert

The added benefit of paying down debt is that your credit score will also improve.

How does the property itself figure into the mortgage formula?

The final consideration in seeking a loan is the real estate involved. The standards have changed in the last few years because of low interest rates, the rising cost of real estate, and the availability of money to lend. However, there are still two things to consider — the loan-to-value ratio and the down payment.

What is a loan-to-value ratio?

One of the standard procedures before making a loan is to determine the value of the property. This is done by an appraisal, which determines a value for the property for loan purposes. The lender may have its own appraisers (in-house appraisers), or it may use an independent (outside) appraiser.

There are several different types of appraisals, some of which are highly complicated and require the appraiser to complete special education and licensing procedures. Appraising a home, especially a tract house or condominium, is relatively easy. The most common appraisal method used is to compare similar properties that have recently sold. A computer database with this information is available to the appraiser, who physically inspects the subject property to assess its condition. The property is then valued based on the sale prices of similar properties in the area, called comparables or comps. If the comps are not exactly the same model as the subject property, a price adjustment is made for square footage, lot size, and any amenities, such as a swimming pool or room addition.

For certain types of loans in which there is an extremely low loan- to-value ratio, the lender may even use a desktop appraisal. With this method, the values of comparable properties are checked on a computer and there is no physical examination of the property beyond a drive by by the appraiser.

The amount of money you ask the bank to lend you compared to the value of the property is the loan-to-value ratio. The lower the ratio, the lower the risk for the lender. For you, the lower the ratio, the lower your credit score can be.

Example: If you wanted to borrow 50% of the value of the property, your credit score would not need to be as high as if you wanted to borrow 90%.

Note: As you have probably noticed by now, your credit score keeps coming up in all phases of the loan. A high credit score will not just give you a better chance to get a loan — it will also save you money on certain fees and on interest.

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