How to Calculate and Improve Your Car Loan to Income Ratio

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.

When applying for a car loan, one of the key factors lenders look at is your debt-to-income ratio also known as DTI. Specifically, they want to see your car loan to income ratio which measures your potential new car payment against your gross monthly income.

Understanding your DTI and how to improve it can make a big difference in whether you qualify for an auto loan, and if so, what interest rates and terms you can get approved for. Let’s take a closer look at what debt-to-income ratio means, how to calculate your car loan DTI, recommended ratios, and tips for lowering your ratio.

What is Car Loan Debt-to-Income Ratio?

Debt-to-income ratio compares your total monthly debt payments to your total monthly gross income before taxes and deductions. It’s expressed as a percentage, with a lower percentage indicating you have more available income to cover an additional debt like a car loan.

There are two main types of debt-to-income ratios:

Front-end DTI – Only looks at housing costs like your rent/mortgage, homeowners insurance, property taxes, and homeowner association fees.
Back-end DTI – Considers all monthly debt obligations including housing costs plus credit card payments, student loans, personal loans, auto loans, child support, alimony, and more.

Since an auto loan is installment debt, lenders primarily focus on your back-end DTI when evaluating a car loan application. However, they may also look at your front-end ratio to see if you have room in your budget after paying for housing.

How to Calculate Your Car Loan DTI

Figuring out your debt-to-income ratio is relatively straightforward Here are the steps

Make a list of all your current monthly debt obligations and the minimum payments. Look at credit card and loan statements or your checking account transaction history.
Add up the total minimum payments due each month Do not include daily living expenses like groceries or utilities
Calculate your gross monthly income before taxes and deductions. Use your annual salary divided by 12 months if you have a steady paycheck. Otherwise, total up income from all sources and divide by 12.
Divide the total monthly debt payments by the gross monthly income amount.

For example:

Rent: $1,000
Car loan: $250
Credit card: $150
Total monthly debt = $1,000 + $250 + $150 = $1,400
Gross monthly income = $4,000
$1,400 / $4,000 = 0.35 (35%)

So the back-end DTI for this example budget is 35%.

What’s a Good Car Loan to Income Ratio?

Most lenders look for your back-end DTI to be 36% or less when evaluating a new auto loan application. Here are some general recommendations:

0-35% – Considered a good, manageable ratio. Better chance of qualifying for best auto loan rates.
36-49% – Adequate but getting stretched. May only qualify for higher interest loans.
50%+ – High and difficult to manage. Hard to get approved for additional financing.

While under 36% is ideal, some lenders may approve ratios up to 45-50% with good credit scores. The higher your DTI though, the higher your auto loan interest rates are likely to be.

Tips for Improving Your Car Loan to Income Ratio

If your DTI is too high, improving your ratio before applying for an auto loan can help you qualify for better rates. Here are some strategies:

Pay down debts – Focus on paying off credit cards and other debts to lower your monthly obligations. Try the debt avalanche or debt snowball repayment methods.
Limit new debts – Avoid taking on additional financing like personal loans until your DTI improves. Too many new accounts can raise red flags.
Increase income – Bringing in more money from a side gig or promotion is an effective way to lower your ratio. Make sure it’s steady income a lender can count on.
Lengthen loan terms – Stretching out existing installment loans over more months lowers the monthly payments used to calculate DTI.
Refinance existing debts – See if you can get a lower monthly payment by refinancing loans or credit cards with better interest rates.
Consolidate debts – Combining multiple payments into one lower monthly payment through a debt consolidation loan can significantly improve DTI.

Remember, the lower your car loan to income ratio, the more affordable any new auto financing will be. So take steps to pay down debts and increase your income in order to qualify for the best rates possible. Monitor your DTI periodically and avoid taking on new financing when it’s too high. With diligent DTI management, you can keep auto loans and other borrowing affordable.

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%.

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.

How Much Car Can You Really Afford? (Car Loan Basics)

FAQ

What is a good car payment to income ratio?

According to our research, you shouldn’t spend more than 10% to 15% of your net monthly income on car payments. Your total vehicle costs, including loan payments and insurance, should total no more than 20%. You can use a car loan calculator to calculate a monthly payment within your budget.

How much should I spend on a car if I make 50000?

50% of Your Income Across All Vehicles Debt-freedom and personal finance guru Dave Ramsey recommends that all of your vehicles combined should be worth no more than 50% of your take-home pay. For a household earning $50,000, that means that all the vehicles combined shouldn’t be worth more than $25,000.

What is the maximum debt-to-income ratio for a car loan?

Debt-to-income ratio	Rating
0% to 36%	Ideal
37% to 42%	Acceptable
43% to 45%	Qualification limits for many lenders
50% and above	Poor

How much should I spend on a car if I make $100,000?

Starting with the 1/10th guideline, created and pushed by Financial Samurai, this guideline states: buy a car in cash that costs less than 1/10th your gross annual pay. If you make $50,000 you should buy a car in cash worth $5000. If you make $100,000, the car you buy should be worth no more than $10,000.