Do you know your debt-to-income ratio? Learn more about your DTI ratio, from how it works to how you can use it to your advantage in your next purchase.
Between credit scores, interest rate percentages, and auto loan term lengths, buying a car incorporates several types of numerical amounts. The term “debt-to-income ratio” represents another figure typical among lenders. However, breaking down the basics of a debt-to-income ratio (DTI ratio) may be simpler than you think. In addition, knowing how to calculate your DTI ratio can help you understand how lenders view your financial situation, specifically in determining your eligibility for a car loan.
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The debt-to-income (DTI) ratio is one of the most important factors lenders consider when approving car loans Your DTI ratio gives lenders insight into your current debt obligations and whether you can afford a new monthly car payment.
In this comprehensive guide. we’ll cover everything you need to know about DTI ratios for car loans including
- What is DTI ratio
- How to calculate your DTI ratio
- Good vs bad DTI ratios
- How to improve a high DTI ratio
- Does DTI affect your credit score?
- DTI vs Payment-to-Income (PTI) ratio
Let’s get started!
What is Debt-to-Income Ratio?
DTI ratio measures your monthly debt payments against your monthly gross income It’s expressed as a percentage
For example, if your total monthly debt payments are $1000 and your gross monthly income is $4000, your DTI would be 25% ($1000/$4000).
The lower your DTI ratio, the better because it means you have more available income to put toward a new car loan payment. Lenders generally look for a DTI of 36% or less.
How to Calculate DTI Ratio for Car Loans
When applying for a car loan, lenders specifically look at your back-end DTI ratio. This includes all monthly debt payments like:
- Mortgage or rent
- Car loans
- Student loans
- Credit cards
- Personal loans
- Child support
- Alimony
It does NOT include living expenses like groceries, utilities, medical bills, etc.
Here are the steps to calculate your back-end DTI:
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Add up all your monthly debt payments. You can find these amounts on billing statements or your bank transaction history. Let’s say your total is $1250.
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Calculate your monthly gross income. If you’re salaried, take your annual salary and divide by 12. For hourly or freelance work, take your total income from tax documents and divide by 12. Let’s use $4000 as an example.
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Divide total monthly debt by monthly gross income. So for our example, $1250/$4000 = 0.3125, or 31.25% DTI ratio.
An easy way to calculate DTI is using an online DTI calculator. Just input your monthly debts and income.
What is a Good DTI Ratio for a Car Loan?
Here are general DTI ratio guidelines for car loan approval:
- 0-35% – Excellent DTI ratio. You should qualify for the best rates.
- 36-49% – Caution zone. May still qualify but with higher rates.
- 50%+ – High risk zone. Unlikely to be approved for a car loan.
Most lenders like to see a DTI ratio of 36% or less when approving car loans. But every lender has their own thresholds, so check with the specific lender.
How to Improve Your DTI Ratio
If your DTI ratio is too high, improving it can help you qualify for a car loan or refinance your existing auto loan at better rates. Here are some tips:
- Pay down existing debts aggressively to lower monthly payments
- Prioritize high-interest debt using the debt avalanche method
- Avoid taking on new debt before applying for a car loan
- Increase your income with a side job or freelance work
- Lower monthly bills by cutting discretionary spending
- Lengthen loan terms to shrink payments (but this raises total interest paid)
With time and focus, you can lower your DTI ratio to a more acceptable level for lenders.
Does DTI Affect Your Credit Score?
Your DTI ratio does not directly impact your credit scores. That’s because credit bureaus don’t have information on your income to calculate DTI.
However, the debts used to compute your DTI are also reported to the credit bureaus. So having high debt relative to your income could indirectly hurt your credit scores. Maintaining low debt balances can help.
DTI vs. Payment-to-Income (PTI) Ratio
Some lenders use another ratio called payment-to-income (PTI) instead of DTI when approving car loans.
PTI only looks at the new proposed monthly car payment against your gross monthly income. For example:
- Potential monthly car payment: $400
- Gross monthly income: $4000
- PTI ratio = $400/$4000 = 10%
PTI only measures the car loan impact, while DTI looks at your entire debt picture. Lenders may consider both when making approval decisions.
The Bottom Line
Your DTI ratio gives lenders a snapshot of how much wiggle room you have left in your budget after covering existing debts.
Aim for a DTI of 36% or less when applying for a car loan. If your ratio is higher, take steps to pay down debts or increase your income. With an improved DTI ratio, you can qualify for better auto loan terms.
How does your debt-to-income ratio affect buying a car?
Your DTI ratio determines how much extra you have each month to put towards a car payment. Lenders want to see that you’ve got plenty of wiggle room to make your monthly car payment, which translates to a lower debt-to-income ratio. If your credit score is low and you have a high DTI ratio, it’s unlikely you’ll be approved for a car loan.
DTI for car loans FAQs
Dealer holdbacks and DTI ratios remain critical components in the car-buying process. Learn more about debt-to-income ratios below.
How to omit your car loan from your DTI
FAQ
What should your DTI be for a car loan?
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Debt-to-income ratio
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Rating
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0% to 36%
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Ideal
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37% to 42%
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Acceptable
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43% to 45%
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Qualification limits for many lenders
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50% and above
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Poor
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What is a good debt-to-income ratio for a car loan?
Less than 36% is considered to be a good debt-to-income ratio. Lenders want to ensure that you’ll be able to afford the loan payments, even if you have a high income. Borrowing a car loan when you have a higher DTI is risky because if you don’t have much flexibility in your budget, you may miss payments if an unexpected expense comes up.
How do you calculate DTI for a car loan?
Auto loan lenders will consider your gross monthly income for the DTI ratio. Simply divide your annual gross salary and divide it by 12 to get your gross monthly income. If you work freelance, are paid hourly, or don’t work regularly, check your 1099 or W-2 form for the total income and divide it by 12.
What does a high DTI ratio mean for a car loan?
When it comes to getting an auto loan, lenders want to ensure you have enough income to cover the new car loan payments in addition to your existing debts. A higher DTI ratio can indicate that you’re struggling to keep up with your current car debt obligations, which may make it harder for you to qualify for a car loan.
How do you calculate a back-end DTI auto loan?
To calculate the back-end DTI auto lenders use when evaluating auto loan applications, jot down your monthly gross income and add up all of your monthly debt payments. Once you have this figure, divide the sum of debt payments by the sum of your monthly gross income to compute your back-end DTI.