Paying down Car Loan to Improve DTI

[Jennifer Connolly]

Hey folks,

I'm planning on getting a preapproval soon, but I have a DTI issue I need to resolve.

I pay $380 per month for my car and have 16 months of payments left on it. Unfortunately, with my low income my current DTI does not give me much purchasing power. On the bright side, I should qualify for both down payment assistance and the Masshousing loan due to my income and first time buyer status, but I still need to get my DTI to be more manageable so I can afford to buy more than a parking space in MA.

A lender I spoke to said that if I pay it down so I have less than nine payments remaining they "may" not factor it into DTI if I have enough liquid funds in the bank to show that I could pay it off and also have enough for a down payment. It's the "may" and the "and" that's getting me LOL

She recommended I do this and then wait for it to hit my credit report before applying for preapproval.

At this point, I could pay the whole thing off with just under $6k, but that would leave me with $5K for a down payment, which would probably be fine assuming a get another $3-4K in down payment assistance, but I hate to assume.

Alternatively, I was thinking I could pay $4K off now, which would leave me with around five payments left just to keep the trade line open a bit longer and probably by the time I get all my ducks in a row and get to closing on a property I might only have one or two payments left on it anyway.

What do you think?

[Stephanie Medellin]

Yes, with less than 10 payments left it should be excluded from your DTI, unless they see you would have a problem making the payments. You just can't pay it down after you've applied for the loan.

On the other hand, if your balance is low enough and you can refinance the car loan to a much smaller payment, that could help your DTI too, without having to lay out too much cash. Not sure how refinancing your car loan right before applying will affect your credit score.

[Jeff B.]

Personally I would wait a year, get the car paid down (if not off). Get the credit scores to recognize the payoff and check credit, DTI is really focused by the banks/underwriters. Plus the car payment is over and now savings for a down payment or assistance on a remodel is in effect.

[Jennifer Connolly]

Thanks for replying @Stephanie Medellin and @Jeff B. . I spoke to the lender at my Credit Union today and he advised paying it down to just under 9 months rather than closing out the tradeline so I'm doing that today!

Jeff, sorry if I didn't make it clear. There's no need for me to wait a year. I have the money now. It's just a tactical decision.

[Jeff B.]

ahhhhhh, gotcha! I was in the same boat you were in, I waited till the car was out of the way so my money wasn't wrapped up in payment and I could use that money for remodeling instead of credit cards.

[Brie Schmidt]

If you pay it down to 9 months it will still show on your credit as 16 months - only the balance will be effected. The amount of payment will not change untill it is paid off

[Jennifer Connolly]

Thanks @Brie Schmidt , I'm aware of that.

[Brie Schmidt]

Ok - just wanted to make sure you were aware that paying it down to only 9 months would be a waste - it would still report as $380 a month for 16 months

[Duncan Taylor]

Pay it off. Then start setting aside some money each month for the next car. I hate car payments more than anything else in this world.

Once the paid off note hits your credit report, you should be just fine.

[Jennifer Connolly]

Hey @Brie Schmidt , I've talked to two lenders and they both adv to partial pay, not pay it off. I will need to show proof of the payment and and write an LOE and show that I have the reserves to pay the balance and then they will exclude from my DTI calculation. They both indicated that it was better to have the reserves and an open trade line, than to have less cash and a closed trade line. I guess I will see what happens, but for now I'm going to follow their advice. I can always pay if things turn out differently.

@Duncan Taylor , my last car I drove for 10 years! It was nice not having a car payment for six of those years. I hope this one lasts me as long. :)

[Duncan Taylor]

Let's hope so. But, if you keep setting aside the equivalent of your car payment, in six years you will be able to pay cash for your next car.

When I buy a car, I keep and drive the thing until the wheels fall off. My primary car in WA is a 13 year old Saab. My car here in GA is a 10 year old Benz.

I have no intention of replacing either of them any time soon.

Not having a car payment is a major accelerator on the road to financial freedom.

[Ned Carey]

Originally posted by @Duncan Taylor:

Not having a car payment is a major accelerator on the road to financial freedom.

To that I would add, when you pay down debt it has the same effect as investing. If your car payment is 8%, paying it off is like earning 8% on your money.

[Jennifer Connolly]

If I were offered an 8% interest rate on a car loan I'd take the bus! Mine's 2.9%.

[Eric Belgau]

I'm not a mortgage underwriter, but as I understand it the problem with closing out a line of credit just before applying for a home loan is that you have to prove it was you (not the institution that issued the credit) who closed it.

In the grand scheme of getting a home loan, given the masses of documentation you have to provide, a letter of explanation and proof that you paid the loan off is kind of trifling. You're right - loan originators beg you not to do it, but I feel that's more an issue of paperwork than any real impact on the loan outcome.

If it were me, I'd pay the car off and write the letter.

UNLESS someone much smarter than me points out that paying the car off will change the math of the deal.

[Jennifer Connolly]

@Eric Belgau , I get what you're saying and honestly it was my first instinct, but for now I'm just going to do what the gang giving me money is suggesting I do.

And wow, the masses of documentation. I'm going to go through a lot of ink and a lot of trees! I'm amassing all the stuff I need to take with me to the interview tomorrow with the folks who run the down payment assistance program. I'm going to go get a binder and make another set for my loan officer since he'll be wanting it all shortly too, I'm sure.

[Mike H.]

But sometimes cash in the bank earning no interest has far more value than the 8% interest that it might return if you pay off a loan balance that is costing you 8%.

Here's the example I use. 7 or so years ago I took out a HELOC for 43k when I first started. I pulled out every penny and stuck it in the bank. I'm still paying 3% on the HELOC money. But that cash in the bank was my bona fides to qualify for loans for investment properties. Without that HELOC, I would not have a single investment property today.

So there are times when the value or return on your money can't necessarily always be calculated on the return you might save. Having cash in the bank might have 100 times more value than paying down a loan somewhere else.

That 43k may be costing me 3% a year right now (my interest only payments are roughly 110 bucks a month). But it was the only reason I was able to invest in real estate to the point that I now have 24 (soon to be 25) properties with a net profit of about 5 to 6k per month.

So what is that money really making me for a return?

There were a couple of key things I heard over and over in my real estate investing readings and one of them is really a good fit here.

1) A lot of investors' biggest regret is selling any property they've every had. A majority of them wish they had kept every single one. So I am buy and hold only.

2) Best product, best price. I started out thinking I should do cheap rehabs. My turnover showed me why that was a bad model. Now I make them nice and have at least one or two things that really pop. Big difference.

3) Cash is king. Having cash in the bank is one of the most important tools an investor can have. Its the difference between investing and not. You can't qualify for loans without it. If you're starting out, you're going to have a far easier time if you have some cash in the bank than if you don't.

So treat your capital as if it were gold - because it is. If you have to take on debt to preserve your cash, do it. You're going to want every penny you can hold onto.

So in this case, I definitely would not pay off that car loan. Not even partially. Refi the thing so you get a much lower payment and that will fix your DTI. It will also help your cash situation today as well since you won't have to continue paying 385 a month. Get it down to 100 a month and save that partial payoff amount plus save yourself the 285 a month for the next few months.

Maybe you pay more interest over the long run but so what. Assuming you're going to use the money to invest in real estate, you're going to make far more money off your investment properties than the little bit extra of interest you're going to pay......

Thats my 3 cents anyway.... (figured it was so long winded it was more than 2 cents worth). :-)

[Matt M.]

I paid off my wife's car before we bought our new place. It was the only way she could qualify when the rates jumped up last year. We had to show proof from Toyota, and the bank accepted it.

[Rob K.]

Sell the car. You can't afford it. Aside from the fact that car payments are for suckers, you stated that you are low income. A car payment shouldn't be a part of your budget. Buy a car for cash for $1,500 or $2,000. Save that $380 each month toward a house.

Car payments are the downfall of the middle class.

[Jennifer Connolly]

Rob, I already save $800 a month so the low income thing was a bit overstated. I'm actually mid-income according to the guidelines for down payment assistance. If I were living outside the northeast I wouldn't even be concerned about the DTI. I'm going to skip selling the car. It'll be paid off shortly after I close anyway.

[Roy N.]

@Jennifer Connolly

If you are saving $800/month in addition to your car payment and living expenses, take that pot and pay-off your car. You will then have 1180/month to replenish your savings.

[Kimo Baenen]

I have to agree with those weighing in to pay it off. But be disciplined, put the 380 in your bank account every month. By the time it filters through your credit report you'll have paid yourself $1000 or more.

As for anyone saying cash is king, you're right, but in this case she's not limited by cash, she's limited by the DTI, which can be dramatically helped by getting rid of a large car payment.

You may have to wait a few months extra to recoup some down money, but you will control the goal, not the bank. If you need the room in your DTI, you're stuck waiting 16 months if you keep the loan (unless you do this exercise again in a few months). If you pay it off, you can figure out a way to recoup that money, starting by saving that 380/mo, but you may find a way to increase it over the next 6 months and end up getting to that paid off, with down, and target DTI much quicker.

The one caveat is if you are helping your credit score by carrying the credit line. If that's the case, you'll get more benefit by paying it off on schedule than by getting rid of it probably. Remember DTI is part of that score too however, so maybe not helping as much as you might think.

[Jennifer Connolly]

Just wanted to let you all know, I decided to pay off the balance on the car loan. I'm mailing my last check today :)

[Roy N.]

Originally posted by @Jennifer Connolly:
Just wanted to let you all know, I decided to pay off the balance on the car loan. I'm mailing my last check today :)

Probably the best move Jennifer. Now you can put the full amount towards accrual of a down payment.