Your debt-to-income ratio (DTI) is one of the things lenders use to measure your capacity to repay the amount of auto loan you wish to borrow. It’s a percentage of your income that’s allocated for paying off your debt. So you may be wondering if you can get a car loan if you have a high DTI ratio.
Yes, you may still qualify for a car loan even if you have a high debt-to-income ratio. There’s no rule or a maximum ratio set for auto loans. It varies among lenders. But according to a study conducted by RateGenuis, 90% of the approved auto loans generally had a ratio of 48% or less.
What is the Ideal Debt-to-Income Ratio?
The lower the debt-to-income ratio, the better. A lower ratio suggests that you have enough earnings to cover your debt. Typically, a percentage of 36% or lower is ideal, but you may have a higher ratio and still get approved. For example, CashUSA.com can connect you to a lender that offers personal loans for applicants with a high ratio.
There’s no official law that determines what is a bad or good ratio for car loans. But lenders follow some general rules of thumb when evaluating the DTIs of applicants.
- 35% and below – Applicants with this DTI reflect healthy finances and a “manageable” level of debt. They most likely have enough money left for spending and saving after paying off their current debt.
- 36% – 43% – Applicants with DTIs that fall between these ranges can still manage their debt but may come up short in case unexpected changes happen to their financial situation.
- 44% – 50% – Applicants with a DTI ratio of more than 43% will find it difficult to get approved for financial assistance. If your DTI ratio is within this range, consider getting a debt management program to improve your number and creditworthiness.
- Above 50% – A DTI above 50% is considered a red flag. You will struggle to find a lender that will accommodate your loan application. Not only that, you’ll be at risk of suffering a financial crisis. It may be prudent to seek some financial advice or budgeting services if you are in this category.
Why is this Ratio Important?
As its name suggests, a DTI ratio represents your total debt relative to your earnings. Lenders check your debt-to-income ratio to determine your ability to pay off your loan. A good debt-to-income (DTI) ratio for a car loan means borrowers have money for repayments.
Meanwhile, a high ratio means borrowers may have problems making repayments. The required ratio varies between lending institutions. Some follow the 43% figure while others may accept applicants with a ratio of 50%, depending on factors like their monthly gross income and balances on your credit cards.
If you have a good DTI ratio:
- You have higher chances of getting approved
- You can get better loan terms
- It can indirectly impact your score positively
- It gives you peace of mind knowing that you don’t carry a lot of debt
Meanwhile, a high DTI ratio:
- Jeopardizes your chance of qualifying for financial assistance
- Prevents you from getting low interest rates
- Prevents you from enjoying the best credit terms
- Cause for worry because you have a lot of debt
Can a poor DTI ratio hurt your credit score? No. Having a poor debt ratio for a car loan won’t hurt your credit score. However, a high ratio may mean you have a lot of debt on your credit cards, which also means you have a high credit utilization ratio. The latter will affect your credit score because it’s responsible for 30% of your credit score.
Although your debt-to-income ratio doesn’t affect your credit score, your balances on your credit cards will affect both your DTI and your credit utilization ratio. So, if you pay your dues diligently and on time, it’ll be beneficial for both these metrics.
How to Improve DTI Ratio for a Better Chance of Car Loan Approval
If you have a high debt-to-income ratio, it’s better to improve it first to increase your chances of getting approved for a car loan. Here are some tips:
- Review Your Expenses
Check your expenses first. Create a list of all your monthly debt payments. For example, your rent or mortgage, credit card debt, student loans, and property taxes. Evaluate all your monthly expenses including your gym memberships, groceries, Netflix subscription, internet, and cable bills – those that have automatic deductions are worth your careful review. Decide which ones you can do without and be disciplined enough to take the corrective action required. .
- Lower Your Debt
There are different ways to pay down your debts. You can use the snowball method wherein you concentrate your payment efforts toward your smallest debt first or the avalanche method where you make minimum payments on all your debts, including your mortgage, except the one that has the highest interest rate.
- Increase Your Gross Monthly Income
You can increase your gross monthly salary by finding a job that pays more or asking for a raise if you think you deserve it. But if these options are not possible, you can also get a part-time job.
- Create A Budget And Stick To It
Budgeting helps you avoid overspending and making unnecessary purchases. It will also allow you to set aside money for debt repayments.
- Consider Refinancing Your Loans
You should also consider refinancing your loan to get better terms like lower interest rates and monthly payments.
How Do I Calculate my Debt-to-Income Ratio?
Here’s the simple formula you can use to calculate your DTI ratio.
- Total the amount of debt that you’re expected to pay, including credit card payments, rent or mortgage payments, personal loans, and student loans.
- Calculate your expected income, including your wages, dividends, etc.
- If your annual gross earnings are $84,000, divide it by 12 months, to get your gross monthly income, which is $7,000. If the total amount you owe per year is $36,000, then your monthly debt payments would be $3,000.
- Divide your monthly debt payments by your gross monthly income per month, and then multiply it by 100. Taking the numbers given above, it’ll be $3,000 divided by $7,000 equals 0.43. Multiply the quotient by 100 and you’ll get 43%, which is your debt-to-income ratio. Even if you use your annual income and annual debt, you’ll get the same answer.
What Other Factors are Considered for Qualification for the Car Loan?
Other factors can affect your chances of securing an auto loan.
- Credit Score – You need a minimum FICO score of at least 660 to get an auto loan with a low-interest rate. Some lenders cater to applicants with bad credit but the loan tends to have high-interest rates.
- Source of Income – You need to prove that you have a steady source of gross monthly income by presenting your recent pay stubs or W-2 form.
- Proof of Residence and Identity – You may need to provide a government-issued ID, driver’s license, and proof of residence so lenders can verify your identity and address.
What Counts as Income for a Car Loan?
Here’s the list of income sources that are considered when you calculate your DTI ratio:
- Salary
- Self-employment income (must be verified via tax returns)
- Tips (if applicable)
- Investment income (rental property, stocks, bonds – must be verified via tax returns)
- Social Security benefits
- Pension
- Child support
- Alimony
- Disability
What is Considered Debt?
Here are the monthly debts that are considered when calculating your debt-to-income ratio:
- Credit card payments
- Home loan
- Student loans
- Personal loans
- Debt consolidation loan
- Child support or alimony payments
- Other payment dues that appear on your credit report
What are the Other Expenses to Consider When Buying a Car?
Owning a car goes beyond the monthly loan payments. You’ll have to consider other expenses, which include the following:
- Regular insurance premiums
- Auto maintenance and repair costs
- Taxes and registration
- Parking fees (if you don’t have a garage)
You will find several car repayment calculators online to help in your calculation of how much mortgage you’re going to be paying every month for the amount of money that would like to borrow.
“How much can I borrow for a car?” That's a fairly common question for car buyers. You can also find free car loan calculators that could give you an estimate on how much fund you can get from lenders based on your credit, gross income a month, and debt factors.
Shop Around To Get The Best Rates
Here are some places that offer loans to people with a high debt-to-income ratio to buy cars or connect you with car or mortgage lenders that accommodate applicants with high DTI ratios. It pays to search around and compare the different rates and amounts offered. Please note that lenders may offer you a car loan but with higher interest rates.
Conclusion
If you’re looking to buy a car and hoping to secure a car loan to finance the purchase, you need to know if you have a good debt-to-income ratio. Lenders use it to determine if you can afford to pay off your bank loan for a car or other types of debts. Calculate your DTI ratio now and determine if you’re in a good position to apply. Find ways to reduce your DTI ratio if it is too high so you’ll have better chances of qualifying for an auto loan, mortgage, and personal loans.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
