Looking for a car loan? Learn more about debt-to-income ratio and how it might affect getting a vehicle loan with this blog post from TDECU.
When you start shopping for a new car, you may envision yourself driving a big, shiny, new vehicle loaded with all the latest features. Before you make a list of all the bells and whistles you want on your vehicle, though, you better first look at how much you can afford to pay each month on a car payment. One way to determine how much you can pay for a new car is to calculate your debt-to-income ratio.
Getting approved for a car loan often comes down to your debt-to-income ratio (DTI). This measures how much debt you have compared to your income. Lenders want to see you can afford the new monthly car payment. Having too high of a DTI can lead to loan denial or higher interest rates.
I’ll explain what car loan income ratio means and how lenders calculate it. You’ll also learn the ideal ratios to aim for and ways to improve yours. This can help you get approved for the best auto financing rates.
What is Car Loan Income Ratio?
Your car loan income ratio compares your total monthly debt payments to your gross monthly income It’s also called debt-to-income ratio or DTI
There are two types of DTI ratios used
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Front-end DTI – Only looks at housing costs like mortgage or rent Used more for home loans
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Back-end DTI – Includes all monthly debt payments like credit cards, personal loans, student loans, car loans, etc. This is what most auto lenders review.
Back-end DTI gives lenders a fuller picture of how much total debt you’re managing each month. The lower your ratio, the less of a default risk you are.
How Lenders Calculate Car Loan Income Ratio
Figuring out your back-end DTI for a car loan is simple. You just divide your total monthly debt by your gross monthly income.
For example:
- Total monthly debt payments: $1,800
- Gross monthly income: $5,000
- DTI = $1,800 / $5,000 = 36%
To find your total debt, add up the minimum payments due each month. Check credit card and loan statements or your banking transaction history.
For gross income, use your pre-tax wages if salaried. Hourly or freelance workers can total income from recent paystubs or tax returns.
Some lenders may also consider child support, alimony, or rental income if you provide documentation. The key is showing steady, ongoing sources of income.
What is Considered a Good Car Loan Income Ratio?
Most lenders like to see your back-end DTI below 36%. But acceptable ratios can vary depending on your overall credit profile and down payment amount. Here are general approval guidelines:
- 0% to 36% – Considered ideal and will help qualify for the best rates.
- 37% to 42% – Still viewed as acceptable by many lenders.
- 43% to 45% – Approval limits for some lenders. May need to shop around.
- 50% and above – Indicates too much total debt burden. Harder to get approved.
A higher DTI doesn’t necessarily mean outright denial. But you’ll often pay more in interest charges. Improving your ratio opens up better loan offers.
How to Improve Your Car Loan Income Ratio
If your DTI is too high, there are ways to improve it over time:
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Pay down current debts – Attack high-interest accounts first using debt payoff strategies like the debt avalanche or snowball methods.
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Avoid new debts – Don’t take on additional credit obligations until you lower your overall DTI.
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Earn more income – Boost your gross income through a side job, promotion, or other means. Ensure it’s steady.
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Reduce expenses – Review spending habits and trim unnecessary costs to free up more cash for debt repayment.
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Refinance existing debt – Consider options to lower interest rates on current loans and credit cards. This cuts minimum payments.
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Make extra payments – Pay more than the minimum due on credit cards and loans whenever possible. This gets balances down faster.
With a lower DTI, you’ll have an easier time getting approved for an auto loan. You can also potentially refinance a car loan later on for a lower rate when your ratio improves.
Monitoring your debt-to-income ratio is key for managing all types of credit. This includes mortgages, personal loans, credit cards, and financing a vehicle. Do your best to keep it at 36% or below. This puts you in the best position for loan approvals with the most favorable interest rates possible.
Frequency of Entities
car loan income ratio: 20
debt-to-income ratio: 16
back-end DTI: 7
gross monthly income: 5
total monthly debt: 5
front-end DTI: 2
Effects of DTI on a New Auto Loan
When you submit a loan application, your DTI ratio and finances will be evaluated. In general, the lower the DTI ratio, the better chance a borrower has of qualifying for a new car loan. However, DTI is just one of several financial metrics used by dealerships, credit unions, and financial institutions when assessing your financial health. Your credit history and credit score are also key factors.
Following are the most commonly used DTI guidelines indicating a low, or good, debt-to-income ratio versus a bad or higher DTI ratio, typically indicating bad credit.
|
DTI Ratio |
Rating |
Financial implications |
|
35% or less |
Good |
Debt is manageable, and you may be able to save money. Ideal range for a new car loan with the best loan terms. |
|
36% to 49% |
Adequate |
Most lenders cap DTI at 46%. With a good credit report, a new car loan is still possible. |
|
50% or higher |
Bad or poor |
Higher DTI limits your ability to get any loans. |
If your DTI ratio is less than favorable, there are steps you can take to improve your ratio, including reducing your total monthly debt payments by making larger monthly credit card payments to pay down the debt more quickly. You can also consider refinancing or debt consolidation to lower the interest rates on loans or credit cards.
Definition of Debt-to-Income Ratio
The debt-to-income ratio (DTI) is the sum of your monthly debt payments divided by your gross monthly income. In other words, what portion of your monthly income goes towards your loans and credit cards each month. DTI ratio gives lenders a view into your financial habits and can help them determine whether a loan approval for you is risky. There are two types of debt-to-income ratio (DTI): front-end and back-end.
Front-End DTI and Back-End DTI Front-end DTI only accounts for monthly housing costs; whereas back-end DTI, which is primarily what lenders focus on, includes all your monthly debt obligations. Back-end DTI includes all loan payments (e.g. student loan payments, mortgage payments, personal loans, auto loans, etc.), plus alimony, child support, and credit card payments. Neither back-end or front-end DTI includes everyday expenses such as utility bills, gym memberships, etc.
How to Calculate DTI Use the following formula to calculate your DTI:
Monthly debt payments ÷ Monthly gross income = DTI ratio.
As an example, someone with a $1,000 mortgage, $500 car loan, and $500 in credit card debt who earns $6,000 in gross income has a DTI of 33%.
Their monthly debt payment is $2,000 ($1,000+$500+$500). The DTI is .33 ($2,000 $6,000). Multiply by 100 to get the percentage of 33%.
How Much Car Can You Really Afford? (Car Loan Basics)
FAQ
What is a good car payment to income ratio?
What is an acceptable debt-to-income ratio for a car loan?
How much should I spend on a car if I make $100,000?
What should your income ratio be when buying a car?
What is the debt-to-income ratio for car loans?
The debt-to-income ratio for car loans is represented by a percentage. It’s a measure of your monthly debt payments compared to your monthly income. When you apply for an auto loan, the lender will check your DTI to assess your creditworthiness. A lower DTI percentage indicates a lower risk for the lender, potentially leading to lower interest rates.
How do Lenders calculate debt-to-income ratio for car loans?
Lenders will consider a few factors into consideration when calculating your debt-to-income ratio for car loans, which we’ve listed below. 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.
What is a good DTI ratio for a car loan?
Typically, lenders like to see a DTI ratio of no more than 45%-50% after factoring in your estimated car loan payment. This means that after accounting for all your debt payments, potential car payments, and insurance costs, you should have at least half of your gross income available for other monthly bills.
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.