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.
Reducing the numbers and calculations you must do monthly can help simplify your budget. With a FINN car subscription, your monthly subscription fee incorporates insurance, registration, depreciation, and maintenance with no hidden fees. FINN also offers as little as six-month terms to fit your lifestyle and remain flexible when necessary.
Getting a new car is an exciting experience. However before you drive that new car off the lot you need to secure financing. Lenders will evaluate your debt-to-income ratio (DTI) when deciding whether to approve you for a car loan.
Your DTI gives lenders an idea of how much debt you have compared to your income. Generally, the lower your DTI the more likely you’ll be approved for affordable car financing.
In this comprehensive guide, we’ll explain what DTI is, how to calculate yours, what’s considered a good DTI, and tips for improving a high ratio. Let’s get started!
What is Debt-to-Income Ratio?
Debt-to-income ratio measures your total monthly debt payments against your total monthly gross income It’s represented as a percentage.
Lenders use your DTI along with your credit scores to determine if you can manage an additional loan payment. There are two main types of DTI ratios:
-
Front-end DTI – Includes just your housing costs like mortgage/rent, property taxes, homeowners insurance, and HOA fees.
-
Back-end DTI – Includes all monthly debt obligations like housing costs plus credit card, auto, student loan, and personal loan payments.
Auto lenders look at your back-end DTI to get a complete picture of your debt load. The lower your back-end ratio, the more affordable a car loan you may qualify for.
How to Calculate Your Debt-to-Income Ratio
Figuring out your DTI only requires two pieces of information – your total monthly debt and gross monthly income. Follow these steps:
-
Make a list of all your monthly debt payments like rent/mortgage, credit cards, auto loans, student loans, child support, alimony, personal loans, etc. Get the minimum monthly payment amounts from your statements.
-
Add up all the payments to get your total monthly debt.
-
Calculate your gross monthly income. If you’re salaried, take your annual pay and divide by 12. For variable income, use your year-to-date or prior year average from your W2, 1099s, and bank statements showing regular deposits.
-
Divide your total monthly debt by your gross monthly income.
-
Multiply the result by 100 to convert to a percentage.
For example:
- Rent: $1,000
- Car payment: $350
- Credit card: $200
- Student loan: $150
- Gross monthly income: $4,000
Total monthly debt = $1,000 + $350 + $200 + $150 = $1,700
$1,700 / $4,000 = 0.425
0.425 x 100 = 42.5% DTI
This borrower has a back-end DTI of 42.5%.
You can also use an online DTI calculator to avoid doing the math yourself. The key is making sure you accurately include all debt obligations and sources of income.
What is Considered a Good DTI for Car Loans?
Most lenders view a DTI under 36% as an excellent ratio. But maximum thresholds vary by lender and loan type.
Here are general DTI guidelines:
- 0-35% – Great DTI range for the best rates.
- 36-49% – May still qualify but will pay higher interest rates.
- 50%+ – Will be difficult to get approved. May need to look for bad credit car loans.
The higher your DTI, the higher your interest rate will likely be. Even being just a few percentage points above a lender’s cut-off could bump you into a more expensive loan tier.
Shopping around with multiple lenders can help you find the most competitive rates for your situation. Expanding your options to include credit unions and community banks may also help.
Tips for Improving Your Debt-to-Income Ratio
If your DTI is too high, taking steps to lower it before applying for an auto loan can pay off. Here are some strategies:
Pay down current debts – Attack your balances with the debt avalanche or snowball methods. Paying off accounts completely will remove them from your DTI calculation.
Avoid new debt – Don’t take on additional obligations like financing furniture or consolidating bills before applying for a car loan. New inquiries and balances will worsen your DTI.
Increase income – Boost your income with a side gig, promotion or new job. Give it time for the extra earnings to be consistent before counting it in your DTI though.
Refinance existing loans – See if you can lower your interest rates by refinancing student loans, your mortgage or an existing auto loan. Just make sure to get estimates beforehand showing how much your monthly payments will decrease to accurately calculate your new DTI.
Lengthen loan terms – Stretching out loan terms lowers monthly payments. Just be cautious of the higher interest costs over the life of the loan.
Get a co-signer – Adding a creditworthy co-signer to your auto loan can help you get approved and snag a lower rate. Just make sure you can handle the payments yourself in case the co-signer is unable to pay.
Improve credit – Boost your credit scores before applying as this may help offset a high DTI. Pay all bills on time, lower balances, and correct any errors on your credit reports.
With some time and fiscal discipline, you can get your DTI ratio back within an acceptable range. Then you’ll be in a better position to qualify for affordable auto financing.
Other Auto Loan Qualification Factors
While DTI and credit scores carry a lot of weight, lenders also consider other elements of your financial profile including:
-
Income – Steady income from employment or other sources.
-
Employment – Length of time at your job.
-
Down payment – The larger the down payment, the less risk for the lender.
-
Loan term – Shorter terms pose less risk.
-
Vehicle value – The loan amount in relation to the car’s value.
-
Collateral – Newer cars hold value better than older ones.
-
Payment history – Having no late payments improves your credit score.
Bringing as many positives as possible to the table can help counteract a less-than-ideal DTI when applying for an auto loan.
Compare Multiple Lenders to Find the Best Rates
While DTI is an important factor, lender underwriting requirements vary. The interest rate you’re quoted will depend on your entire financial picture, not just DTI alone.
Comparing personalized loan offers from several lenders is the best way to discover your real auto financing options. Here are some tips for getting the lowest rate:
-
Shop rates from online lenders, banks, credit unions, and your own financial institution. Cast a wide net.
-
Get pre-qualified to view estimated loan terms and rates before applying. Accepting too many hard inquiries can dent your credit.
-
Compare both new and used car loan rates. New auto loans tend to have lower interest rates.
-
Expand your used car search to include certified pre-owned vehicles. CPO loans offer new car loan rates for lightly used cars.
-
Look at shorter loan terms if you can afford higher payments. You’ll pay less interest over the life of the loan.
-
Apply with a co-signer if your credit needs a boost. Make sure you feel comfortable making the payments if needed.
-
Consider taking cash instead of 0% dealer financing if the rate is under 3%. You can likely beat 0% interest through an outside lender.
Casting a wide net and pre-qualifying with multiple lenders can help you discover the best financing for your budget and debt situation.
Use Your Improved DTI to Refinance Later On
Let’s say you purchased a car but didn’t have the best DTI at the time. As long as you make your payments on time, you may be able to refinance for better terms later.
Here are some tips for refinancing your auto loan down the road:
-
Pay down debts and increase your income to lower your DTI.
-
Keep your vehicle well-maintained and in good condition. No dents or scratches.
-
Wait at least 1 year before applying. Lenders want to see a solid payment history.
-
Check your credit reports and fix any errors to maximize your scores.
-
Obtain loan estimates from multiple lenders to find the lowest rate based on your improved financial profile.
-
Pick a shorter loan term if you can handle higher monthly payments. You’ll save on interest costs over time.
-
Make sure the savings in interest and lower payments exceed any refinancing fees to come out ahead.
Refinancing for a lower rate can help you pay off your car faster and save substantially on interest charges. Improving your DTI before applying gives you the best shot at scoring the most favorable terms.
Maintain Good Financial Health
Your DTI ratio provides a quick snapshot of how much you owe versus earn each month. Keeping
How to improve your DTI
Improving your debt-to-income ratio can help you pay off a car loan faster and may even gain you valuable preapproval for a car loan. Relying on a strategy remains one of the best ways to improve your DTI. Below are a few ideas to help get you started:
- Minimize debt by removing unnecessary charges or services
- Work on paying off existing debts, either from smallest amounts to largest or vice versa
- Establish a side hustle or other form of income, even if it’s only a small contribution
- Refinance your existing loans for longer terms and lower monthly payments
- Avoid adding more debt, even if it’s only a few dollars per month
- Consider debt counseling or consolidation
- Ask for a raise at work or invest in overtime
Similar to your credit score, spending some time improving this ratio has significant consequences for your financial well-being, regardless of what type of loan you’re after. A lower debt-to-income ratio could mean the difference between obtaining a car loan and facing rejection. If you can determine your DTI ratio before submitting preapproval applications, you can also avoid needless credit checks that further jeopardize your chances for approval.
What is a debt-to-income ratio?
When you break it down, your debt-to-income ratio juxtaposes your monthly debt and income. This ratio determines how much you spend on debt to reveal what leftover funds are available to cover additional expenses, such as an auto loan. Lenders may also categorize your DTI ratio as “front-end” or “back-end”:
- Front-end: Your front-end DTI ratio determines how much of your gross (pre-tax) income goes toward housing expenses. Mortgage lenders often rely on this type of DTI ratio for qualifying potential homeowners.
- Back-end: Basic and back-end DTI ratios express all your debt payments and their relationship to your monthly income. If your monthly debt totaled $1,500 and you earned $2,000 gross, your DTI ratio would be 75%.
Your DTI ratio doesn’t include living expenses such as grocery or utility bills. While your debt-to-income ratio doesn’t impact your credit score, the two are closely related. Higher DTI ratios often indicate you’re using more of your credit, affecting your credit utilization and score. Lenders that see a high debt-to-income ratio often cite it as the cause for denying your loan application.
Outside of applying for loans or credit cards, DTI ratios can also signify overall financial health. A higher DTI may trigger you to reduce your monthly debt to increase your savings and improve your credit score. Specific DTI ratios can also give you a goalpost to aim for in determining what amount of debt is manageable.
How to Calculate Your Debt to Income Ratios (DTI) First Time Home Buyer Know this!
FAQ
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 car can I afford DTI?
How much should I spend on a car if I make $100,000?
What is the debt-to-income ratio for a car lease?
How does debt-to-income ratio affect car loans?
Your debt-to-income ratio (DTI ratio) is one such factor that lenders use to determine how much money you earn each month and how much you spend on debt repayment. While there’s no set debt-to-income ratio for car loans, knowing how it impacts your loan approval is important. What Is Debt-To-Income Ratio and How Does It Impact Car Loans?
How can I calculate my debt to income ratio for a car loan?
To calculate your debt-to-income ratio for a car loan, you need to divide your total monthly debt payments by your gross monthly income.This will give you a percentage that represents how much of your
How much money do you need for a bad credit car loan?
The gross income requirement for a bad credit car loan is typically a minimum of $1,500 to $2,500 a month. This income needs to be taxable – meaning tips or side hustles that aren’t being reported won’t count. If you’re a server, driver, or any other professional that relies on tips, be sure you’re reporting them. Minimum income is also important.
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.