To achieve financial security, consumers need to effectively manage their debt by following several key tips that include paying debt in a timely manner. How do you avoid overextension? How do you manage debt? The most valuable tool for manipulating debt involves analyzing your debt-to-income ratio (DTI). To assess DTI, determine your monthly debt payments and divide this number by your gross monthly income.
How to Avoid Becoming Overextended
When considering the risk involved with loaning money, lenders use DTI to measure your capacity for making monthly payments. Lenders don’t use an absolute principal when it comes to DTI guidelines. Commonly, mortgage lenders want to see a DTI around 35% to 36%. However, some lenders allow this ratio to reach 43% to 45%.
At the upper end of the debt scale, 45% is generally the highest DTI allowed when applying for a mortgage. DTI of 36% or less is preferred by lenders. No more than 28% of your DTI should go towards paying rent or paying down a mortgage. For consumers to be fiscally responsible, they should use a personal budgeting tool called the 50 30 20 rule.
This means that consumers can allow 50% of their income to go towards necessities such as mortgages and auto loans; 30% could go towards spending that includes entertainment; 20% should go towards putting money into a savings account or applying part of the 20% for investment purposes such as stocks.
These rules are not absolutes. If you’re carrying a significant amount of debt, you could follow the 60 20 20 rule. In this scenario, 60% of your income should go towards necessities that include paying off debt. This approach works best if you plan to apply for a mortgage in the near future. When considering a mortgage, you should apply no more than 28% of your gross monthly income toward your home loan.
DTIs and Auto Loans
When auto lenders consider DTI, they prefer that the borrower has a ratio no higher than 45% to 50%. When handling an auto loan, the borrower could find himself or herself upside down – this means that you owe more on the loan than the value of the vehicle. To address this situation, the consumer should either sell the vehicle or refinance their loan.
When purchasing a vehicle, borrowers should consider the duration of the loan. A 72 month loan – six years – will often come with a high interest rate. When prioritizing a budget, the consumer should avoid loans over 60 months whenever possible. Your auto loan will go towards the 50% category of your budget when utilizing the 50 20 30 rule.
Rules to Follow for Auto Loans
As a general guideline, the borrower should use the 20 3 8 rule that stipulates you should apply 20% as a down payment on your vehicle; you should pay the loan in three years; and you should spend no more than 8% of your gross income on your car payment.
Another key tip addresses the need to pay your loans and credit cards on time. Your FICO score can be impacted by as much as 180 points when delinquent. This number fluctuates depending upon the severity of the late payment – how much money was delinquent - and the frequency of late payments. What qualifies as delinquent? These errors won’t show up on your credit report for at least 30 days after the missed due date.
Whom Do Predatory Lenders Target?
Once you’ve achieved a good FICO score – 700 to 850 – you will need to shield your financial well-being from predatory lenders who use questionable sales tactics that steer you into purchasing a high-interest loan. These interest rates and absorbent fees make it difficult to meet your monthly obligations. You need to protect your assets by avoiding these types of lenders. Some borrowers are more likely to become a victim of predatory lending than other borrowers.
Low-income families – even with a good FICO score – are more likely to be a target for predatory lenders. Subprime borrowers are also often the target of predatory lenders. These borrowers tend to have a poor FICO score - around 630 - and the lender will take advantage of this situation by talking the borrower into a high-interest loan. Elderly people are also often targets of these types of lenders.
More Tactics of Predatory Lenders
Elderly homeowners are popular targets because they live on a fixed income that might not be enough to cover the cost of home repairs, medical care and other expenses. The predatory lender could encourage the borrower to tap into the equity in their home. The lender then offers them high interest loans with unfavorable terms. This is called equity stripping.
Predatory lenders also use bait-and- switch tactics. The borrower could be unaware that a higher interest rate will become applicable several months into the loan. Packing is another tactic. These loans charge for services you didn’t need or request. Packing commonly involves inducing borrowers to believe that credit insurance must be purchased and financed to qualify for the loan.
Predatory lenders also use a tactic called loan flipping. These loans use refinancing to gain access to your assets. The typical situation involves a predatory lender who gets the homeowner to repeatedly refinance their loan. The lender also persuades the borrower to accept terms with a higher loan principal each time.
Hidden balloon payments are another tactic. The borrower is under the impression that they have applied for a loan with a low interest rate, only to learn that this is a short-term loan that will require refinancing within a few years. Many times, balloon payments are hidden within the contract that requires the borrower to pay the full amount of the loan at the due date. Failure to meet this obligation will result in foreclosure.
Solutions for Victims of Predatory Lenders
If you are a victim of predatory lending, you should report your situation to the Federal Trade Commission (FTC). You can contact the FTC at 1-877-FTC-HELP. You can also write to the FTC in Washington D.C. to explain your objectives. During this process, you should contact a reputable lender to refinance your loan. This can be difficult, so you should research lenders. Look for people who have substantial experience in the mortgage business. Local lenders could be preferred.
The Federal Deposit Insurance Corporation (FDIC) addresses the problem of dishonest lenders by taking actions that inform the lender that their lending practices are being reviewed by the agency. The FDIC will recommend changes that impact the practices of the predatory lender. The FDIC will determine whether the processes of the bank need to be modified – operational and financial conditions will be monitored by the agency to determine whether changes should be applied.
It can also be beneficial to attain the services of an established, local lender who can originate and service the loan. If the borrower has questions about his or her loan, they can go to the local office and meet face-to-face with the lender. If you use the services of financial advisors, they could guide you in the direction of a lender who can meet your needs and help you maintain an effective DTI and FICO score.