You know your credit score affects whether you are approved for an auto loan. But what about your debt-to-income ratio? Learn what lenders look at with your ratio.
Your lender will want to see a debt-to-income ratio that is under 36 percent. That being said, you may still be able to get an auto loan if it is slightly higher.
Learn more about your debt-to-income ratio, including how to calculate it and how it affects your auto loan.
DTI For Car Loan: What To Know
Debt-to-income ratio is a phrase used to describe your monthly payments on debts owed in comparison to what your gross monthly income is. This is an important number for auto lenders and is also known as DTI. Lenders use the ratio to get an idea of what you can and can't afford for car payments.
Whether your DTI is good for you to get a car loan depends on the particular lender. Generally, a lower ratio is better.
How To Calculate Your Debt-To-Income Ratio
When auto-lenders look at your DTI, they use back-end DTI, as opposed to your front-end DTI. We will focus on how you can calculate this number.
To calculate your DTI, add all your monthly debt payments up. If you don't have the figures handy, then check credit card statements and your bank statements for the exact amounts.
Then, add up your monthly gross income. For those who make a salary, take your annual amount, and divide by 12. For those with an income that varies or that comes from a variety of sources, use these documents for reference:
- Alimony or child support court orders
- W-2 tax or 1099 tax forms
- Bank statements for the past 3-6 months showing deposits
- Statements for pensions, social security, and other benefits
- Official investment statements
Once you have your total debt payments in a month and your total monthly gross income, divide the debt by income.
DTI Formula (With Example)
As mentioned, the DTI formula is the sum of total monthly debt payments divided by the sum of total monthly income payments. The following example shows you how to calculate this ratio.
Assume your debts are as follows:
- Rent – $800
- Student Loans – $400
- Credit Card Payments – $175
- Total = $1,375
And your income is as follows:
- Salary – $3,500
- Side Jobs – $1,000
- Total = $4,500
You would divide $1,375 by $,4500 to get .3056 or 30.56 percent. This final figure is your debt-to-income ratio.
Debt To Income Ratio Calculator For Car Loan
If you don't feel like doing the above math by hand, you can also easily find a debt-to-income ratio calculator online. There are many of these that will handle the calculation for you and convert the final answer into a percentage.
Some calculators will require you to add up your income and debt payments yourself ahead of time. Others will have fields to fill in the most common types of debt or income. These tools will also have at least one section for "other" details in case your debt or income source isn't listed.
What Is Considered A Good DTI? What Is A Good Debt To Income Ratio For A Car Loan?
When your lender looks at your debt-to-income ratio, he wants to see something below 36 percent. That being said, it does depend on the lender and if there is wiggle room. When your DTI is on the higher end, start looking for tips to get it lower.
With a DTI of 36 percent to 49 percent, your debt is on the edge of being unmanageable and may prevent you from some loans. You may want to look for debt counseling. You can look at nonprofits like NFCC or National Foundation for Credit Counseling.
When your DTI is 50 percent and above, you are not likely to get approval for most loans. The best thing to do in these situations is to look at counseling and debt relief programs.
Does Debt-to-Income Affect Credit?
No, your debt-to-income ratio will not affect your credit score. But remember that lenders will still take it into account when deciding whether to approve you for an auto loan.
It is also important to know that many of the same factors that affect your DTI will affect your credit score. For example, your credit utilization ratio, which accounts for 30 percent of your score, includes a similar calculation. However, it focuses on revolving credit, such as credit cards.
Your DTI Is Too Low – How to Improve It
If your debt-to-income ratio is above 36 percent, then you should try to do what you can to lower it before applying for an auto loan.
You can work toward one or both of the following goals:
- Increasing your income
- Reducing your debts
Of course, this is easier said than done. If you decide to focus on reducing your debts, there are several strategies to consider. You can start with the smallest balance or the highest interest rate. Or if your goal is to improve your DTI, you can calculate which debt affects your DTI the most and focus on that.
If you want to increase your income, consider working more hours, getting another job, or adding a side hustle. Keep in mind that any area where you can cut costs will be helpful. Even if it doesn't directly reduce your debts or increase your income, it gives you more disposable money that you can put toward your debt.
For example, having a streaming service does not affect your DTI at all. But if you cancel it, you could put the same amount that you paid for the service into your debt every month. This would slowly bring the debt balance down.
Best Practices for Your DTI Right Before an Auto Loan
While it will take time to improve your DTI ratio, there are some things you can start doing as soon as you know you will be applying for an auto loan.
Put Off Major Purchases
The most important task is to consider putting off large purchases. If you put off a large purchase, you:
- Will have more funds to either pay down your debts or put toward your car's down payment
- Will potentially reduce the debt factored into your DTI
In addition to putting off major purchases, do your best to avoid more debt. This includes both other types of loans and extra charges on your credit card.
Make Extra Payments on Your Debt
While you need time to see major changes in your DTI, you can sometimes see smaller changes in just a few months. So, see where you can cut costs and use those savings to pay off your debt. If you can increase the amount you pay toward your debt every month, your ratio can improve more quickly than you realize.
Keep reading: Different Types of Income [MOST COMMON EXAMPLES]
Track Your DTI
If you know you will be applying for an auto loan soon, then calculate your DTI right away. This will give you a good idea of where you stand and how much you need to improve it. As a bonus, tracking your DTI lets you see how much progress you have made in improving it. Don't forget to pay attention to your credit score as well.
Car Payment Percentage Of Income
The rule of thumb that most people tend to follow is spending ten percent or less of your monthly pay after taxes on a car. There is a bit of flexibility if you budget this way. Consider some of the following advice:
Before shopping, take a long look at your budget. Figure out what you are comfortable paying each month. This is just as important as the cost of the car. The payment should be less than 10 percent of your take-home paycheck. Another factor you should consider is that the total price of the car should be less than somewhere between 15 to 20 percent of your yearly income.
This may make you feel that you can't afford a decent vehicle. If you consider your budget and balance your spending, however, things will look different. You should put 50 percent of your income for needs such as housing, food, and transportation. Another 30 percent should be for your wants, such as travel and entertainment. The final 20 percent should be for savings and paying off credit cards.
While 10 percent of your take-home money for a car will seem extreme, when you look at the entire budget and work it in a balanced fashion, it will make sense.
Remember Your Loan Payment Is Not the Only Car Cost
As you figure out how much you can afford to spend on your car, don't forget to consider the other costs of car ownership. For example, the following are all expenses car owners should expect:
- Maintenance and repairs
Your debt-to-income ratio is the ratio of all of your monthly debt-related expenses to your total monthly income. Most auto loan lenders want to see a percentage that is 36 percent or lower. You may be able to get an auto loan if it is slightly higher, but this is more challenging. As such, it is smart to calculate your DTI and try to improve it, if necessary, before applying for an auto loan.
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Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.