Understanding Your Income to Debt Ratio When Getting an Auto Loan

Getting a new car is an exciting prospect, but the process of getting approved for an auto loan can be stressful. One of the key factors lenders consider when reviewing your application is your income to debt ratio. Also known as your debt-to-income ratio (DTI), this number gives lenders an idea of your ability to take on more debt.

In this article, we’ll explain what the income to debt ratio is, how it’s calculated, and what ratio you’ll need to qualify for competitive auto loan rates. We’ll also provide tips on how to improve your ratio if it’s too high With this knowledge in hand, you can feel confident navigating the auto loan process.

What is the Income to Debt Ratio?

Your income to debt ratio compares the amount you owe each month to the amount you earn. To calculate the ratio, you divide your monthly debt payments by your gross monthly income.

For example:

• Monthly debt payments: $1,000
• Gross monthly income: $4,000
• $1,000 / $4,000 = 0.25
• 0.25 converted to a percentage is 25%

So if your monthly debt payments are $1,000 and income is $4,000, your DTI is 25%.

The resulting percentage represents the portion of your income that goes toward debt payments. The higher the percentage, the more strained your budget is.

Why Income to Debt Ratio Matters for Auto Loans

When you apply for an auto loan, lenders want to see that your income sufficiently covers existing debts plus the new car payment. A high DTI suggests you may struggle to make payments, so you’re seen as a higher credit risk.

Lenders have maximum DTI requirements. To qualify for the best auto loan rates, you’ll want your ratio well below the lender’s cutoff. Otherwise, you may pay more in interest or get denied altogether.

How Lenders Calculate Your Auto Loan DTI

Lenders use your back-end DTI to evaluate auto loan applications. This includes all recurring monthly debt payments like:

• Mortgage or rent
• Credit cards
• Auto, student, and personal loans
• Child support or alimony
• Insurance premiums
• Other debts with a monthly payment

It does not include living expenses like utilities groceries or medical bills.

To find your back-end DTI, add up all these monthly payments and divide by your gross monthly income. Be sure to document income sources like paystubs, bank statements, and tax returns.

What’s Considered a Good vs. Bad DTI for Auto Loans

Here are general guidelines on good and bad DTI ratios:

• Excellent: 20% or less
• Good: 21-35%
• Fair: 36-49%
• Poor: 50% or higher

You’ll get the best auto loan rates with a DTI of 35% or less. Ratios of 36% or more will make approval difficult and raise your interest rate.

Keep in mind, an excellent credit score can sometimes offset a higher DTI. But it’s still smart to aim for the lowest ratio possible.

Tips for Improving Your Income to Debt Ratio

If your DTI is too high, here are some ways to reduce the number before applying:

• Pay down balances: Focus on paying down credit card and other high-interest debt.
• Consolidate debt: Consider consolidating multiple payments into one lower monthly payment.
• Increase income: Take on a side job or ask for a raise at your main job.
• Lower monthly bills: Look for ways to reduce expenses like downsizing housing, trimming subscriptions, or refinancing debt.

Even an improvement of a few percentage points could help you qualify for better loan terms.

Alternative Auto Loan Options for High DTI

If you need a car but your ratio remains high, here are some options that may approve you:

• Subprime lenders: Specialize in applicants with past credit issues. Rates are higher but they’re often more flexible on DTI requirements.
• Buy here pay here dealers: Provide their own in-house financing so can tweak requirements. Inventory is limited to older used cars.
• Co-signer: Adding a co-signer with better credit can help you qualify and get better rates.

As a last resort, you may need to buy an inexpensive used car with cash until you can improve your financial standing. Then you’ll be in a better position to finance a nicer vehicle.

The Takeaway on Income to Debt Ratio and Auto Loans

Your DTI gives lenders a snapshot of how much wiggle room you have in your budget. To score the best auto loan offers, strive for a ratio below 35% – but the lower the better.

Take time to understand and improve your income to debt ratio before applying. With a little preparation, you can show lenders you’re ready to take on an auto loan responsibly.