How Debt to Income Ratio Affects Your Car Loan Eligibility

Buying a new car is an exciting experience. After years of driving your old clunker, you finally have the chance to get that stylish new ride you’ve been eyeing. But before you can drive off the lot, you need to secure an auto loan. To get approved, lenders will examine your debt-to-income ratio. So what exactly is DTI and how does it impact your chances of getting a car loan?

As an average consumer wanting the best interest rate, I had to learn the ins and outs of debt-to-income ratio. After researching extensively online and talking to lenders, here is what I discovered.

What Is Debt to Income Ratio?

Debt-to-income ratio (DTI) is a percentage that compares your monthly debt payments to your gross monthly income It gives lenders a snapshot of how much of your income is tied up in paying debts each month.

To calculate your DTI, you divide your total monthly debt payments by your total monthly gross income before taxes and other deductions. For example:

• Gross monthly income: $5,000
• Total monthly debt payments: $1,500
• $1,500 / $5,000 = 0.3
• 0.3 x 100 = 30% DTI

In this example, the borrower has a DTI of 30%. That means 30% of their income goes toward debt payments each month.

Why DTI Matters for an Auto Loan

When you apply for a car loan, lenders examine your debt-to-income ratio to determine if you can afford the new monthly payment. Auto loans are installment loans, meaning you repay the balance over several years in equal monthly payments. Lenders want to see that your income is enough to cover the new car payment plus your existing debts.

Borrowers with lower DTIs have more available income to put toward a car payment. Those with higher DTIs have less wiggle room in their budget for the added expense. That’s why your DTI is a key factor lenders consider when approving loans.

Generally, the lower your DTI, the better chance you have of qualifying and getting a decent interest rate. But maximum DTI limits vary by lender.

What is Considered a Good DTI for an Auto Loan?

Many lenders like to see your DTI below 36% to approve a car loan. But some may allow higher ratios, even up to 50% DTI or more. Here are general DTI thresholds to be aware of

• Excellent DTI: Under 36%
• Good DTI: 36-42%
• Fair DTI: 43-50%
• Poor DTI: Over 50%

With a DTI in the excellent or good range, you should have a good shot at getting approved and securing a competitive interest rate But as your ratio creeps higher into the fair or poor range, it gets harder to qualify.

Every lender has their own underwriting policies regarding DTI limits. The best rates and terms often go to borrowers with lower DTIs. Shop around with multiple lenders to see who offers you the best deal based on your individual financial situation.

How to Lower Your DTI to Improve Loan Eligibility

If your DTI is on the high side, taking steps to lower it can boost your chances of getting approved for the car loan you want. Here are some tips to reduce your ratio:

• Pay down existing debts, especially credit cards. This lowers your monthly payments.

• Ask lenders about excluding certain debts from the DTI calculation, like a mortgage.

• Get a cosigner with better credit and income to strengthen your application.

• Extend loan terms to reduce the monthly payment, if needed.

• Increase your income with a side job or gig work for a few months.

• Avoid new debts like credit cards and personal loans when applying for a car loan.

Even marginal improvements can make your DTI more attractive to auto lenders. I managed to lower mine from 42% to 36% by paying off some credit cards and having my partner co-sign my application. That made all the difference in getting approved for a 2.49% rate.

How Lenders Calculate DTI for Auto Loans

When calculating your DTI, lenders look at two main factors – your total monthly debt and your monthly gross income.

Debts Included in DTI

For auto loans, lenders typically include:

• Mortgage or rent
• Credit card minimum payments
• Student loan payments
• Personal loan payments
• Child support or alimony
• Existing auto loans
• Any other recurring debts

To get the full picture, be sure to disclose all these debts on your application, even if they don’t show up on your credit reports.

Income Sources Counted in DTI

Your gross income includes money you bring home from:

• Your full-time job(s)
• Part-time jobs or side gigs
• Self-employment
• Investment income
• Social Security/disability
• Alimony or child support
• Any other regular income

Use your total gross income, before any deductions are taken out. Certain lenders may only count your base salary. So be prepared to provide pay stubs, tax returns or bank statements to document all your income streams.

Sample DTI Calculation for a Car Loan

Let’s look at a sample DTI calculation for a car loan applicant:

• Gross monthly income: $4,000
• Existing auto loan: $200
• Student loans: $300
• Credit card minimums: $150
• Rent: $1000
• Total monthly debt: $1,650

$1,650 total monthly debt / $4,000 gross monthly income = 0.4125

0.4125 x 100 = 41.25% DTI

With a DTI of 41.25%, this borrower falls in the fair range. Their chances of approval may be questionable with some lenders but decent with others who allow higher ratios. Reducing their DTI could increase their options.

Always tally up your own individual debts and income to determine your ratio when applying for an auto loan. This gives you the full picture of how lenders will assess your application.

The Impact of a High DTI on Your Car Loan

The higher your DTI, the harder it may be to get approved for a car loan – or the worse your loan terms will be. Potential impacts of a high DTI include:

• Higher interest rates
• Lower loan amounts approved
• Shorter repayment term requirements
• Need for a down payment
• Necessity of a cosigner, even if you have good credit
• Complete denial of loan application

Lenders see high DTIs as riskier, so you’ll pay for it with stricter loan terms. You may need to shop around quite a bit to find a lender willing to work with your specific situation. Casting a wide net and comparing options across multiple lenders is key.

Tips for Managing a High DTI

If you have a high debt-to-income ratio, take steps to reduce it prior to applying for an auto loan. Here are some smart money management tips:

• Get on a budget to limit unnecessary spending each month. Tracking your cash flow helps control debt.

• Make payments higher than the minimum on credit cards. This slashes the balance quicker.

• Consolidate multiple debts into one lower monthly payment through a personal loan or balance transfer card.

• Talk to student loan servicers about income-driven repayment plans to potentially lower payments.

• Speak with credit card companies to request lower interest rates or reduced monthly minimums.

• Avoid taking on new consumer debt as much as possible.

• Increase your income via promotions, a raise, second job or part-time gig work.

• Save up a larger down payment over time so you can finance less.

With some fiscal discipline and smart strategies, you may be able to get your DTI down to a range where lenders look upon your application more favorably. Don’t let a high ratio deter you from ultimately getting the keys to your new ride.

Should You Include Your Car Payment in DTI Calculation?

When calculating your own DTI to assess affordability, it’s smart to include your estimated new car payment. But when lenders actually evaluate your application, they don’t yet know the exact loan amount and terms to determine the payment.

So for the DTI calculation used on your loan application, lenders only look at your current monthly debts. Once approved, they will ensure the new payment fits within your budget.

If the proposed monthly car payment greatly inflates your ratio, the lender may counter by offering you a longer loan term or lower loan amount. Then they re-assess if your new DTI including the car payment still meets their limits.

So while estimating your new DTI with the car loan gives you an idea of affordability, the application DTI only factors in existing debts. This helps prevent inflated ratios.

The Takeaway on DTI and Auto Loans

As an average consumer, I learned first-hand the