Debt to income ratio

[Danno]

Hey Gang,
Recently I had to come up with cash for a surgery that my son needed($2,600). The doctor required the funds up front, so i thought I would open an account with Care Credit. They give a 6 month interest free loan. Well, I applied by phone and was denied....shocked the heck out of me. I'm pretty sure that since I have no missed payments, it's either a mistake, or it's my debt to income ratio. I ran a credit check and discovered my DTI ratio was high...everything else was perfect. Not sure what my score was, because I didn't want to pay for that info. Main reason my DTI ratio was high is because I refinanced to a 5% 15 year loan 4 years ago, bought a new vehicle 2 years ago, and took out a 2nd mortgage 1 year ago. Things got tight for us and I sold one of my toys that netted me 30K. So right now I have about 35K sitting in savings. My 1st has a balance of 125K(1465/mo inc TI), 2nd is at 7.99% with a balance of 32K(325/month), car loan at 6% and balance of 14 k(325/mo), we now have a credit card balance of 14k, 1 card 9k at 0%, 2nd card 5k at 10.9 %. I still owe 500.00 on son's ortho plan. Net income is 4k per month. Currently, 15k of my savingsi s in high yield CD's earning 4.25%, and the remaining 15-20 k is earning 2.75%. Son is going to college in the fall and I'm scared to death I'm going to go broke. I would greatly appreciate any sage advice before my savings are depleted from trying to stay afloat.

Danno

[Philip Brewer]

Besides your debt-to-income, another one to look at is your debt-to-assets ratio. Is that more than 1? Because if it is, you're already broke--in the sense that you owe more money than your assets are worth.

This is actually a common situation for Americans these days--and a lot more common now than it was in the recent past, because falling home prices have put so many people underwater on their mortgages.

As far as sage advice, that really doesn't change--live within your means. In particular, live far enough within your means as to free up cash to pay off the debts.

If you were asking whether it makes sense to use your savings to pay down your debt, it probably does. Figure out how much money you need to keep on hand for liquidity purposes (to smooth out fluctuations between when the bills come due and when the paychecks come in), add to that three or six months spending as an emergency fund, and anything over that should go to paying off debts. (Starting with the highest-interest debt saves you the most money, but some people find that paying off any small debts that you can eliminate completely gives them a feeling of accomplishment that makes it easier to push on ahead with the debt reduction.)

In any case, I certainly wouldn't borrow money to pay for an operation when I had ten times as much in savings. That's what the savings are for.

[SouthShoreGirl]

I agree with the above poster. I am home on maternity leave now (and our child is of course being fashionably late to arrive!) and not bringing in much income for the next few months. We've already had to tap into our savings for some things, and plan to over the next few months (hospital co-pay is one of those things). It sucks, but at least I know we CAN build that back up. I'd rather do that than just put it on one of the credit cards. It seems like once you start charging, that debt takes much longer to go away. At least seeing my savings build back up, even a little bit at a time, is a positive for me!

[Julie Rains]

I think it is great that you have $35K in cash but I would also (like Philip and SouthShoreGirl) recommend not taking out another loan and paying from your savings. Though I understand the need to conserve cash, the debt load is heavy and you could consider paying the 10.9% credit card balance off soon, and either the 0% if the teaser rate will expire soon or the car loan. Then you will have more money to pay your other bills, including the car loan and the equity line.

I have a teenager in the house ( I am thinking your son is a teenager) and know that they can be expensive! Controlling his college costs would be the one place I would look to save money, even if it means going from Plan A (you pay everything) to Plan B (he contributes in a few ways or everything). He can help you control your expenses based on his choice of college, college credits he may already have (AP classes or courses taken at the community college, for example), work, federal loans, and scholarships. I just wrote a post on scholarships btw.

At some point, you might consider going with a 30 year loan just to lower your debt-to-income ratio, but it would make more sense to start paying the other debt first and controlling expenses as best you can.

[Danno]

Thanks for the replies....really appreciate everyone's insight. I guess I thought I would be better off using someone elses money at 0% for 6 months than taking it out of savings....that was my reasoning. Would it make good sense to refinance our mortgage and consolidate all debt(about 185k) now that mortgage rates are down under 5%. I know that might sound like the easy way out, but I don't want to miss my window of opportunity with rates so low. Our home is valued at 210k-220k, so if we refi'd I could pay the difference from savings to keep our LTV below 80% and still have a nice nest egg in savings. My son's tuition will be around 7k per semester. He earned a 20k scholarship that is allocated at 2500 per semester, which helps alot. My goal was to get him through the first two years of college w/o taking out any student loans....then maybe get help with low interest student loans. As much as I hate the thought of refinancing, it would sure ease the load and allow us to sock away more into savings every month. Btw, our debt to assets is below one. Both my wife and I work and have 401k's and ESOP's in addition to our regular household assets, but we are far from wealthy.....especially with the economic setbacks that have plagued us over the last several months. I know it might make better financial sense to dip into the savings to pay off some debt, but our savings represents a comfort cushion that gives us a great peace of mind....especially in the economic climate we are currently in. Once again, thanks much for your input....I truly appreciate it.

Danno

[Julie Rains]

My concern about the refi is that you might not be able to qualify with the current debt load but that is something you could see a loan officer about, and obviously the concern about adding more non-mortgage debt after the refi with college expenses being added to the mix. You might also look into the best way to allocate your resources so that your son could qualify for federal student aid (low-interest loans).

[singleguymoney]

Danno - From experience, I can say that I would certainly use some of your savings to pay off the debt. I was in the same situation where I had a huge amount of cash savings but I also had a lot of debt. I felt that the cash in the bank represented security but I eventually took the plunge and pulled a nice chunk of money from my savings and pay off debt. It is much easier to build your savings back up once you pay off that debt.

[Philip Brewer]

Everybody ought to have an emergency fund, even people with debts. The key, though, is to size the emergency fund correctly. It's easy to imagine that a bigger emergency fund equals more security, but that's an oversimplification. Paying down debts has a bunch of security advantages that cash in the bank doesn't.

As just one example, there were a lot of news stories over the past year about people who were paying their debts just fine--until the lender suddenly raised the interest rate. In some cases (the ones who got in the news), the higher rates were enough to break the borrower--they were just managing to make ends meet when their debt was at 7%, but when it spiked up to 29%, they couldn't make payments any more. You're much less vulnerable to that sort of problem when your debts are small--not to mention that it's much less likely to happen. (High debt-to-income ratios were exactly what the lenders were targeting for their penalty rates.)

Besides security, the other reason to have both debt and savings at the same time is when you can borrow money cheap and get a good return on your savings. I never found that very compelling even when you could borrow at 0% and save at 5%, because I'm much more interested in making my life simple than I am in picking up a little extra money. Now that it's hard to get much over 3% on your savings, it's an even less compelling story.

I wrote a post a while back on figuring the size of your emergency fund.

[Danno]

Thanks for the advice and suggestions....appreciate it. Still not entirely sure wheteher I should refi and consolidate, then curtail the principal with extra payments. Paying off credit cards(14k) saves me 150/month(making minimum payments). Paying off our vehicle(14k) saves 325/mo. Paying off 2nd(32k) saves 325/mo. If we refi to a 15yr 5% loan and consolidate everything, we save approx. 600/mo. By 'save' I mean reduce our monthly outflow. Appreciate your feedback.

Danno

[SouthShoreGirl]

Just think about all the money you could sock away if you paid off some of those debts! I know it's hard-----trust me I'd hate to see our savings completely wiped out.