Earlier this week I received the following email from a reader:
I’m writing because recently I have been trying to consolidate my private loans and have run into a snag: I have too much debt with regard to my income (surprise!). I have excellent credit and make the huge payments on time. However, I have been rejected by all the banks up to this point. I would think that since I already make my payments I would be able to make payments at a lower interest rate. I have not seen this talked about yet but I imagine others may run into this problem. I feel trapped. Have you seen this problem before?
This is a very common problem. Anyone with even an average amount of student debt may run into debt-to-income ratio issues. The first thing to address here is to be more specific about your problem. Outside of a few exceptions, the issue is not total debt as much as it is monthly debt relative to monthly income. When creditors make evaluations, one of the most important factors they look at is how much you make each month compared to how much you are expected to pay each month. If your monthly debt eats up too big a portion of your income, a rejection is likely in your future. However, if you plan smart, you can quickly improve your personal finances in the eyes of creditors.
[Note from the Sherpa: This article will discuss private consolidation and refinancing… borrowers looking for more information on federal government consolidation of federal student loans have entirely different steps and rules to consider.]
Keep up the good work
Step number one is to continue to do what you are already doing. Maintaining your excellent credit score will be an asset when it comes time to apply next time. Not missing any monthly payments is critical, as is being careful not to do anything else that could bring down your score. That means you should avoid applying for refinancing, or any other credit, until there is a significant change in your creditworthiness (more on that later). If your credit is run frequently, by different entities, over a long period of time, creditors will see this as desperation and it will negatively impact your score.
Along the same lines, it is important to fight the temptation to make any large or small purchases that will impact your credit. Adding a car payment could dig you into an even deeper hole. Similarly, if you are thinking about buying a new computer or tv and will be carrying a balance on your credit card to pay for it — don’t. These purchases will only put up more roadblocks on your way to get your debt straightened out.
Choose Your Battles
Most people looking to consolidate or refinance their student loans have a number of debts. Paying them all off is usually not possible, so you need to be smart about how you attack your debt. Remember, when it comes to improving debt-to-income ratios, the goal is to reduce your monthly payment obligations. A reduction of your total debt balance, though a major step forward, doesn’t do much to help your ability to consolidate.
If you have credit card debt, this is often the best place to start. If you are carrying a balance, creditors will look at your minimum monthly payments when calculating how much debt you can afford. If you reduce your credit card debt by half and your minimum payment goes down by half, you become more creditworthy. This is a noteworthy difference from student debt, mortgages, and car loans. With most other consumer debt, paying more than the minimum reduces your principal balance, but your monthly payment does not change.
If you are not carrying credit card debt, you will likely need to pick off a debt that you can pay off entirely. The most effective debts to eliminate are those with low balances, but high monthly payments. A student loan that has a high monthly payment but is nearly paid off would be the ideal loan to target.
A low balance, high monthly payment debt is where you will get the most bang for your buck. For example, a car loan could have a much lower balance than some of your other debts, but a monthly payment that is much higher due to the shorter length of the loan. Get rid of this debt and your application becomes much better.
Targeting debt in this manner is not the most efficient way to eliminate debt… that requires paying off the highest interest rate debt first. However, if eliminating a single payment puts a borrower in a position to refinance sooner, it may end up being the ideal route. The problem is that it is impossible to know what that future savings might be.
- If you pay off your credit card, don’t cancel it. Having an open line of credit with a low or zero balance, helps your credit score.
- Paying off your car loan first may help your monthly debt-to-income ratio the most, but if the interest rate is much lower than your other debts, it may make the most sense to be attacking your high interest debt first.
- Apply with many different lenders. We are currently tracking about 20 different student loan consolidation and refinance lenders. Each lender uses different underwriting criteria and one may say yes where others have said no.
- There are a few lenders that borrowers struggling to gain approval should consider: LendKey works with a massive network of local credit unions and has higher approval rates. SoFi used to be very picky, but as they have grown, they have become far more forgiving. Laurel Road recently slashed rates and has been approving at a higher rate than usual.
- The suggestions made in this article apply to more than just student loan consolidation. If you are trying to qualify for a mortgage or a business loan, the same lessons apply.
- Reducing debt isn’t the only way to improve your monthly debt-to-income ratio. If you get a big raise at work or find a newer or better job, you will have a much stronger application.
Turning Refinance and Consolidation Rejections into Approval
If you have gone for months meeting all of your obligations, it seems silly that a lender wouldn’t be willing to lower your payments based upon your past successes. Unfortunately, monthly debt payments will always play a huge roll in your ability to get credit. If you use this information and get crafty about how you attack your debt, you will be well on your way to scoring lower interest rates on your private student loan consolidation.