Understanding Debt Income Ratios for Car Loans

Getting a new car is an exciting experience. But before you start test driving your dream vehicles it’s important to assess whether or not you can realistically afford the payments. One of the key factors lenders consider when approving car loans is your debt-to-income (DTI) ratio.

What is Debt-to-Income Ratio?

Your debt-to-income ratio compares your total monthly debt payments to your gross monthly income. It is shown as a percentage, with a lower percentage indicating you have more available income to put toward a new debt like a car loan.

Lenders use your DTI to determine if you can manage adding a new monthly car payment to your existing financial obligations. There are two main types of DTI ratios lenders look at:

• Front-end DTI – Compares your monthly housing costs like rent or mortgage to your income. Auto lenders generally do not use this.

• Back-end DTI – Compares all your monthly debt payments including housing, credit cards, student loans, etc. to your income. This is what most auto lenders focus on.

How to Calculate Your DTI for a Car Loan

Figuring out your back-end DTI is simple:

1. Add up all your current monthly debt payments. This includes your mortgage or rent credit cards student loans, personal loans, child support, insurance, etc.

2. Calculate your gross monthly income. For salaried workers, take your annual salary and divide by 12. For hourly or freelance workers, use your year-to-date totals.

3. Divide your total monthly debt payments by your gross monthly income. This gives you your back-end DTI percentage.

For example:

• Monthly debt payments: $2,000
• Gross monthly income: $5,000
• $2,000 / $5,000 = 0.4 or 40% DTI

What is Considered a Good DTI for a Car Loan?

The ideal back-end DTI ratio for a car loan approval is 36% or lower. Here’s a breakdown of DTIs and what they mean:

• 0-36% – Considered ideal and likely to get approved for the best rates
• 37-42% – Still in good shape but may not qualify for lowest rates
• 43-49% – Approval limits for many lenders, may need to shop around
• 50%+ – Considered high and may make approval very difficult

So for example, if your back-end DTI is 28%, you are in a great position to get approved for competitive car loan rates But if your DTI is 46%, you may struggle to get approved or have to accept higher interest rates.

Tips for Improving Your DTI to Get a Car Loan

If your DTI is on the high side, here are some tips to improve it before applying for an auto loan:

• Pay down existing debts – Consider using the debt snowball or avalanche method to pay off credit cards and other loans to lower your monthly payments.

• Avoid taking on new debt – Don’t open any new credit cards or financing until after you are approved for the car loan.

• Increase your income – Look for ways to earn more money through raises, bonuses, freelance work or side jobs. Make sure the extra income is steady before counting it.

• Extend loan terms – Getting a 72 or 84 month car loan term can lower your monthly payment and thus your DTI. But this also increases the total interest paid.

• Make a larger down payment – Putting down more money upfront on the car purchase price reduces the amount you have to finance and can lower monthly payments.

• Use a co-signer – Having a cosigner with better credit and income may help you get approved and improve the interest rate offer.

• Improve your credit – A higher credit score can help offset a less-than-ideal DTI ratio when applying for a car loan.

Keeping your DTI ratio low and managing debts responsibly over time can help ensure you get approved to finance a new or used car. Check your DTI before visiting dealerships so you know what budget and loan terms you can qualify for.

What Happens If You Get Declined for a Car Loan?

Don’t despair if you get turned down for an auto loan – there are still options:

• Apply with subprime lenders that offer financing for borrowers with credit challenges. Rates are higher but they may approve you.

• If your DTI is the main issue, work on paying down debts and improving your credit score, then reapply in 6-12 months.

• Explore lease options that have lower monthly payments than financing the full car purchase price.

• Save up to buy a cheaper used car with cash so you avoid needing a loan.

• Trade in your current vehicle and put the equity towards a newer used car to lower the amount you need to finance.

While a high DTI ratio makes getting a car loan more difficult, focusing on debt reduction and credit improvement can set you up for success down the road.

Other Factors in Auto Loan Approval

Along with your debt-to-income ratio, there are a few other key factors lenders consider when reviewing applications:

• Credit score – Having a credit score of 670 or higher results in better chance of approval and lower interest rates. Scores below 620 will be challenging.

• Income stability – Auto lenders want to see steady employment and income history without large fluctuations.

• Loan term requested – The longer the term (like 72-84 months), the more risk for lenders, so you may not qualify for extended terms if your DTI is higher.

• Down payment – The more money you put down, the less financing required, reducing risk of default. Some lenders require a minimum down payment.

• Vehicle value – The loan amount in relation to the car’s value impacts approval chances and interest rates.

While you can’t change some factors overnight, maintaining a low DTI ratio is one of the most effective ways to improve your chances of auto loan approval and get the best interest rates.

Alternatives If You Can’t Get an Auto Loan

For those with debt-to-income ratios over 50%, an auto loan may simply be out of reach right now. Here are a few alternative options to get a vehicle without financing:

• Buy an inexpensive used car with cash – Save up to pay $5-10k for an older used car that you can buy outright without financing. Avoid high-interest subprime loans.

• Use public transportation – Consider ridesharing, buses, trains, etc. if available in your area while you work to pay down debts and improve your financial health.

• Borrow a vehicle – Ask to borrow a car from a friend or family member temporarily until you can get a vehicle of your own. Offer to cover gas, maintenance, etc.

• Rent a car – Long term rental through Hertz, Avis, etc. may cost less than financing if you have bad credit and high DTI. Shop around for best weekly/monthly rental rates.

• Join a car sharing program – Services like ZipCar allow you to rent vehicles hourly/daily and include insurance and gas. More flexible than traditional rentals.

The most important thing is not rushing into a car loan that overburdens your finances. Be patient, reduce debts, and explore all options before committing to a vehicle you can’t realistically afford based on your income and expenses.

Summing Up Debt-to-Income Ratio for Auto Loans

Carefully considering your debt-to-income ratio before applying for a car loan can help set expectations on what you can qualify for and the interest rates you’ll pay. Maintaining a DTI of 36% or lower will put you in the best position for approval. If your DTI is higher, take time to pay down debts, increase your income, improve your credit, and explore options to get your ratio to a more ideal level before purchasing a vehicle. This discipline will pay off with access to better auto financing terms in the long run.