How Debt to Income Ratio Impacts Your Ability to Get an Auto Loan

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.

Your debt to income ratio (DTI) is one of the most important factors lenders consider when deciding whether to approve you for an auto loan. In this comprehensive guide, we’ll explain what debt to income ratio is, how it’s calculated, what a good DTI ratio is, and most importantly – how you can improve your DTI to get approved for the best possible auto loan.

What is Debt to Income Ratio?

Debt to income ratio (DTI) measures your monthly debt payments against your monthly gross income. It shows lenders what percentage of your income is being used to pay off debts.

There are two types of DTI ratios

Front-end DTI – Includes just your housing costs like rent/mortgage property taxes, homeowners insurance, HOA fees etc.
Back-end DTI – Includes all your monthly debt obligations like housing costs, auto loans, credit cards, student loans, personal loans etc. Auto lenders look at your back-end DTI.

How is DTI Calculated for Auto Loans?

Calculating your debt to income ratio is simple:

Total Monthly Debt Payments / Gross Monthly Income = DTI

Let’s look at an example:

Rent: $1,000
Credit Card Minimum Payment: $200
Student Loan Payment: $300
Gross Monthly Income: $4,000
Total Debt Payments = Rent + Credit Card + Student Loan = $1,000 + $200 + $300 = $1,500
Gross Monthly Income = $4,000
DTI = Total Debt Payments/Gross Income
= $1,500 / $4,000
= 0.375
Convert to percentage by multiplying by 100
= 0.375 x 100 = 37.5%

So this person’s DTI is 37.5%

To calculate your DTI, make a list of all your monthly debt obligations – housing costs, loan payments, credit card minimums etc. Add them up to get your total monthly debt payments.

Then calculate your gross monthly income – take your annual pre-tax income and divide by 12.

Divide total debt payments by gross income to arrive at your DTI percentage.

What is a Good DTI Ratio for an Auto Loan?

A good DTI for an auto loan is below 36%. Lenders generally look for a DTI of 36% or lower when approving auto loans.

Here are some general DTI guidelines:

0-35% – Excellent DTI, you’ll likely get approved for the best rates
36-49% – Fair DTI, you may face challenges getting approved
50%+ – Poor DTI, will be very difficult to get approved

However, acceptable DTI thresholds can vary significantly by lender. Some may approve loans for borrowers with DTIs as high as 50-60%. So focus less on an ideal number and more on improving your DTI before applying.

How Does DTI Affect Your Auto Loan Terms?

The higher your DTI, the higher risk you represent to lenders, and the worse your loan terms will likely be. Here’s the impact of DTI on auto loan offers:

Lower DTIs (below 36%) – Will qualify for the lowest advertised interest rates and longest loan terms
Higher DTIs (36-50%) – May only qualify for higher rates or shorter loan terms
Very high DTIs (above 50%) – Will likely only get approved for subprime loans with high rates and unfavorable terms

That’s why it’s so important to reduce your DTI before applying for an auto loan. Even a small decrease can qualify you for much better loan offers.

How to Improve Your Debt to Income Ratio

Here are some tips for lowering your DTI to boost your chances of auto loan approval:

1. Pay down existing debts

Focus on paying down your credit card, personal loan and student loan balances. Even an extra $100-200 a month can make a difference. The debt avalanche or debt snowball methods can help you decide which debts to focus on first.

2. Avoid taking on new debt obligations

Before applying for an auto loan, try not to open any new credit cards or take out personal loans. New debt obligations will worsen your DTI.

3. Increase your income

Boosting your income will increase the denominator in the DTI equation and lower your ratio. Consider taking on a side job or freelance work to supplement your income.

4. Have a co-signer with a lower DTI

If your DTI is high, having a co-signer with better credit and lower DTI can improve your chances of approval and secure better rates. Make sure the co-signer understands the responsibility they are taking on.

5. Improve your credit score

A higher credit score can help offset a less-than-ideal DTI. Work on improving your credit by paying bills on time, lowering balances, and correcting errors on your credit reports.

6. Make a larger down payment

A larger down payment reduces the amount you need to borrow, and it shows lenders you’re financially committed. If you can put down 20% or more, lenders may overlook a higher DTI.

7. Shop around with multiple lenders

Each lender may assess DTI a little differently. Applying with several lenders improves your odds versus relying on just one. Cast a wide net when auto loan shopping.

8. Prepare documentation to verify income

Lenders may ask for proof of income, tax returns, bank statements etc. to confirm your gross income if you have a high DTI. Having clean, easy-to-verify documentation will make approval easier.

9. Consider getting a secured auto loan

Secured auto loans require you to collateralize the loan with a CD or savings account. This reduces the lender’s risk, making them more likely to approve higher DTIs. Just be prepared to temporarily tie up your funds.

Following these tips, you can lower your DTI and set yourself up for auto loan success, even if you start off with a high debt-to-income ratio. Monitor your DTI periodically, and aim to keep it below 36% whenever possible. This will ensure you get the best rates not only now, but also when you go to purchase your next vehicle.

debt to income ratio auto loan

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%.

KEY FACTORS You Need to Know about Credit Scores and Car Loans (Former Dealer Explains)

FAQ

What is an acceptable 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.

Is 7% a good debt-to-income ratio?

DTI is one factor that can help lenders decide whether you can repay the money you have borrowed or take on more debt. A good debt-to-income ratio is below 43%, and many lenders prefer 36% or below. Learn more about how debt-to-income ratio is calculated and how you can improve yours.

Is a 20% debt-to-income ratio bad?

35% or less is generally viewed as favorable, and your debt is manageable. You likely have money remaining after paying monthly bills. 36% to 49% means your DTI ratio is adequate, but you have room for improvement.

Can you get a car loan with a high debt-to-income ratio?

If you have a high debt-to-income (DTI) ratio, getting approved for a car loan will be more of a challenge. Lenders are ideally looking for a below 36% DTI for car loan . If it’s higher than this, it means you’ve already taken on a lot of debt, and that raises red flags.

Can I get a car loan with a high DTI ratio?

Getting a car loan with a high DTI ratio is possible under the right circumstances. Many special financing lenders, such as buy-here-pay-here dealerships, may consider borrowers with high DTI ratios. However, you can also get a new loan with a high DTI ratio if you:

What is a good debt-to-income ratio for a car refinance?

While mortgage lenders prefer a debt-to-income ratio below 36%, many auto refinance lenders have a maximum of 50% — others don’t have a maximum at all. A good rule of thumb is to keep your DTI below 50% to increase your odds of getting approved for a car refinance loan.

What is a good debt to income ratio for a car loan?

Based on these figures, your back-end DTI would be roughly 35 percent ($2,250/$6,500). What’s a Good Debt to Income Ratio for Car Loans? Ideally, you want a DTI below 36 percent to have the best chance of getting approved for a car loan with favorable terms.