Understanding Your Debt to Income Ratio When Getting a Car Loan

Your debt to income ratio (DTI) is one of the most important factors lenders look at when you apply for a car loan. It gives them a clear picture of how much debt you currently have compared to your income. Knowing your DTI can help you understand your chances of getting approved and the interest rate you may qualify for In this comprehensive guide, we’ll explain everything you need to know about debt to income ratio for car loans

What is Debt to Income Ratio?

Debt to income ratio (DTI) measures how much of your gross monthly income is being used to pay off debts, It is calculated by dividing your total monthly debt payments by your gross monthly income

For example, if your total monthly debt payments are $1000 and your gross monthly income is $4000, your DTI would be 1000/4000 = 025 or 25%

The resulting percentage indicates the share of your income that goes towards servicing your debts every month. A higher percentage means more of your income is tied up paying debts, leaving you with less money available for other expenses.

Why DTI Matters for Car Loans

When you apply for a car loan, lenders assess your ability to manage the new loan payment along with your existing debts. DTI gives them a simple metric to evaluate this.

Borrowers with lower DTI have more disposable income available after paying monthly debts. This means they are at lower risk of missing payments if their income drops suddenly. On the other hand, high DTI indicates the borrower is already stretched thin financially. Adding another loan payment may be difficult for them to manage.

That’s why lenders prefer to lend to borrowers with low DTI. They represent a lower credit risk. As a result, low DTI borrowers tend to get better loan terms like lower interest rates. High DTI borrowers are seen as riskier and usually have to accept higher rates.

Front-end vs Back-end DTI

There are two main types of DTI used in lending:

• Front-end DTI – Only includes your monthly housing expenses (mortgage/rent, property taxes, insurance etc.). Does not factor in other debts.

• Back-end DTI – Includes your monthly housing costs plus all other minimum debt payments like car loans, student loans, credit cards etc.

Most auto lenders will look at your back-end DTI when assessing a car loan application. This gives the full picture of your total debt obligations. Front-end DTI focuses just on housing costs and ignores your other debts.

How to Calculate Your DTI for a Car Loan

Figuring out your own DTI is simple if you have the two main pieces of information:

Total Monthly Debt Payments – Add up the minimum monthly payments due on all your current debts. This includes credit cards, auto loans, student loans, personal loans, mortgage/rent, and any other regular debt payments. Don’t include utilities, groceries etc.

Gross Monthly Income – Your total monthly income from all sources before deductions and taxes. Use your pre-tax salary if on payroll. Otherwise add up income from your tax return or bank statements.

Let’s see an example DTI calculation:

• Rent: $1000

• Car Loan 1: $200

• Car Loan 2: $100

• Credit Card 1: $50

• Credit Card 2: $75

• Student Loan: $300

• Total Monthly Debt Payments = $1000 + $200 + $100 + $50 + $75 + $300 = $1725

• Gross Monthly Income = $5000

Debt to Income Ratio = Total Monthly Debt Payments/Gross Monthly Income
= $1725/$5000
= 0.345
= 34.5%

So this person has a back-end DTI of 34.5%. We simply divided total monthly debt by gross monthly income to arrive at the DTI ratio.

Many online DTI calculators and car loan calculators can automate the math for you. But it’s good to know the manual calculation as well.

What is a Good DTI for Car Loan Approval?

Most lenders see a DTI of 36% or lower as a good ratio for approval. Borrowers with DTI in this range are likely to get approved and offered better interest rates.

Here are the general DTI tiers lenders use to assess credit risk:

• 0-35% – Excellent DTI. Low risk of payment problems. Best chances for approval and lowest rates.

• 36-49% – Fair DTI. Moderate risk of payment issues. May get approved but with higher interest rates.

• 50%+ – Poor DTI. High risk of non-payment. Unlikely to be approved for additional loans.

These thresholds can vary slightly between different lenders. Many set maximum DTI limits between 40-50% for auto loan approval.

The higher your DTI, the fewer lenders may be willing to finance your car purchase. Shop around for lenders that accept higher DTI ratios if yours is above 40%.

How to Improve Your DTI to Get Better Car Loan Offers

If you already have a high DTI, here are some tips to improve it before applying for a car loan:

• Pay down balances – Focus on paying off debts with the highest balances and interest rates first. This will lower your monthly payments.

• Consolidate debt – Combine multiple high-rate debts into one lower rate debt via a consolidation loan. Reduces overall monthly payment.

• Ask for lower payments – Contact creditors and negotiate lower payments through rate reductions or extended repayment terms.

• Increase income – Boost your income through a side job, promotion, bonuses etc. A higher income will lower your DTI.

• Avoid new loans – Don’t take on additional debt until your DTI improves to get better rates on future loans.

• Improve credit – Pay all bills on time and correct errors on your credit reports to boost your credit scores. This allows access to lower rate loans.

• Add a co-signer – Ask a family member with good credit to co-sign the car loan. Their income and credit can offset your high DTI.

With some work, you may be able to improve your DTI significantly in 6-12 months. This can open up far better auto financing offers once you are ready to apply.

Sample Car Loan Terms at Different DTI Levels

To give you an idea of how DTI affects your loan terms, here are sample used car loan offers at 20% vs 40% DTI levels:

| Loan Terms | DTI = 20% | DTI = 40% |
|