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.
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Getting approved for an auto loan often comes down to your debt-to-income (DTI) ratio This simple calculation shows lenders how much of your income is tied up in debt payments each month A higher DTI ratio could make it harder to get approved or lead to higher interest rates.
In this article, we’ll explain what debt-to-income ratio is, how it’s calculated, and how you can improve your DTI to boost your auto loan chances.
What is Debt to Income Ratio?
Your debt-to-income ratio compares your total monthly debt payments to your gross monthly income. It’s expressed as a percentage.
For example if your monthly debt payments total $1,000 and your gross monthly income is $4,000, your DTI would be 25% ($1000/$4,000).
Auto lenders look specifically at your back-end DTI This includes all monthly debt payments like
- Auto loans
- Mortgages
- Credit cards
- Student loans
- Personal loans
- Child support
- Alimony
It does not include living expenses like utilities, groceries, medical bills, etc. The lower your back-end DTI, the more likely you’ll be approved for a car loan.
Why DTI Matters for Auto Loans
Lenders want to see that your income is enough to manage an additional loan payment. They use your DTI to assess if you can truly afford a car loan.
Along with your credit scores, debt-to-income ratio gives lenders a snapshot of your creditworthiness. The higher your DTI, the riskier you look. You may be charged higher interest rates or denied altogether.
On the flip side, a low DTI paints you as a lower-risk borrower. You’re more likely to be approved and could qualify for the lender’s best rates.
How to Calculate DTI for Auto Loans
Figuring out your DTI is fairly simple if you have two key numbers:
Total Monthly Debt Payments: Add up the minimum monthly payments for all your debts. Check statements or your banking transaction history to find these amounts.
Gross Monthly Income: Take your annual salary or self-employment income and divide it by 12.
For example:
-
Monthly debt payments:
- Credit card: $200
- Student loan: $300
- Mortgage: $1,500
- Total debt payments: $2,000
-
Annual salary: $60,000
- Gross monthly income: $60,000/12 = $5,000
-
DTI = Total Monthly Debt Payments/Gross Monthly Income
- $2,000/$5,000 = 40%
In this example, the DTI is 40%. That’s on the high end of what lenders prefer to see.
What’s Considered a Good DTI Ratio?
Most lenders like to see your DTI below 36%. But maximum DTI thresholds vary.
Here are general DTI guidelines:
- 0-35%: Debt looks manageable. You have a good chance of approval.
- 36-49%: Debt may be unaffordable. You’ll likely pay higher rates.
- 50%+: Debt is probably unmanageable. Loan approval will be very difficult.
The type of lender also impacts DTI limits. For example:
- Mortgage lenders often cap DTI at 43%
- Online lenders may approve DTIs around 50%
- Prime lenders stick to 36% or lower
- Subprime lenders may allow DTIs up to 60%
Shop around among different lender types if you have a high DTI. You still may be able to qualify for a car loan.
How to Improve Your Debt to Income Ratio
If your DTI is too high, taking steps to lower it can boost your auto loan eligibility. Here are some tips:
Pay down current debts: Focus on paying off credit cards and other debts to reduce your monthly payments. The debt avalanche or debt snowball methods can help make progress.
Avoid new debts: Hold off on financing another car until you improve your DTI. Applying later with a lower ratio can help you land better rates.
Increase income: Take on a side gig or find ways to earn extra cash that you can report as income. Just make sure it’s steady.
Lengthen loan terms: Stretching out an auto loan to 6 or 7 years lowers the monthly payment. This decreases your DTI. But it also means paying more interest over the long run.
Use co-signers: Adding a creditworthy co-signer with a low DTI can offset your high ratio. Their income helps you look like a better borrower.
Shop around: Compare rates across multiple lenders. Those targeting near-prime or subprime borrowers may approve higher DTIs.
Improve credit: Payment history is a major factor in your credit scores. Making on-time payments can increase your scores over time, boosting loan eligibility.
Provide explanations: If you went through hardships like a job loss or medical crisis that led to high debt, explain this in your application. It provides context for the lender.
The Takeaway
Your debt-to-income ratio gives lenders a quick look at how much wiggle room you have in your budget. Keeping your DTI as low as possible boosts your chances of auto loan approval and qualifying for the best interest rates available.
Take steps like paying down debts, limiting new borrowing, and shoring up your credit to keep your DTI in check. This can help ensure you get approved the next time you need to finance a car.
What is a high debt-to-income ratio?
DTI ratios often contribute to how long you can get a car loan for and even if you can have two car loans simultaneously. The table below summarizes DTI ratios in a lender’s eyes:
|
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 |
High debt-to-income ratios range from around 40% to above 50%. If you spend more than half of your paycheck on debts, it’s time to reconsider what debts you can reduce or do away with. You can also look into increasing your income to offset your existing debt.
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.
How Much Car Can You Really Afford? (Car Loan Basics)
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
|
Is a 7% debt-to-income ratio good?
How much should I spend on a car if I make $100,000?
What is an acceptable debt-to-income ratio for a loan?
How do I calculate my debt-to-income ratio for a car loan?
Lenders may also consider another calculation: the payment-to-income (PTI) ratio. In this case, you’d add up estimated car loan payments, plus vehicle insurance costs, and divide this figure by your gross income. Here’s how to calculate your debt-to-income ratio for a car loan: Step one: Determine your monthly gross income.
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.
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?