Debt to Income Ratio on Car Loans

February 1st, 2022 by

The debt-to-income ratio is how much your debt payments are per month related to your gross monthly income. More commonly known as DTI, this calculation is one of the main tools to judge whether or not you can afford the potential auto-loan payment. A good DTI is a subjective term and varies from lender to lender, but the salient point is that the lower your DTI is, the better your odds of being approved for an auto loan.

Debt-to-Income Ratio Explained

A collage of different words related to debt and income

Debt-to-Income” licensed under CC BY 2.0 via Flickr by EpicTop10.com

Conceptually, DTI is quite simple to calculate by taking your total monthly debt payments and dividing them by your gross monthly income. What isn’t as well known is that there are two different DTI ratios, front-end and back-end DTI. While auto lenders will typically, if not exclusively, utilize your back-end DTI in determining your creditworthiness, it is important to understand them both.

Front-end DTI only utilizes expenses related to monthly housing costs such as your rent or mortgage payment, homeowner’s or renter’s insurance, and property taxes. It doesn’t consider other debts, such as other auto loans, credit card payments, personal loans, or student loans.

Meanwhile, back-end DTI is what most people think of when DTI is discussed and what most lenders are referring to when considering DTI. Back-end DTI considers every monthly payment you have for any debt type. Examples include child support or alimony, auto loans, credit cards, and student loans. With back-end DTI, everyday expenses like utilities and groceries are not considered. Another exclusion from back-end DTI is medical bills. Even though a debt, these are excluded until a collection agency becomes involved. Once the medical bills go to collections, the collection agency’s payments are included in the back-end DTI.

Regardless of what DTI calculation you are using, front-end or back-end, gross income per month is used instead of net monthly income. Gross income refers to the total salary paid per month before any deductions, including health care, retirement investments, income taxes, and Social Security payments. When applying for an auto loan, the application typically requires your annual gross income, other income sources, and any assets.

Another ratio that auto loan lenders will occasionally use is called the payment-to-income ratio or PTI. This ratio is a more straightforward calculation, so some lenders prefer it. To calculate PTI, divide the potential monthly auto loan payment by your gross monthly income. You should look to keep all transportation expenses under 10% of your total monthly income.

Calculating Debt-to-Income Ratios for Auto Loans

Auto lenders typically utilize back-end DTI, if not exclusively, so that is the one we’ll discuss how to calculate. Here are step-by-step instructions to calculate your back-end DTI: 

  • Determine and add up all of your monthly debts. If you’re uncertain about exact amounts, just review your bank and credit card statements. This review will also help ensure you don’t miss anything.
  • Determine your gross monthly income. For salaried employees, just take your annual salary and divide by 12. Meanwhile, freelancers or hourly workers can look at your most recent tax forms such as 1099 forms or W-2s to get your annual salary and divide that by 12.

If you don’t have those forms available, use your most recent paystubs to garner data for a week, or two weeks, whatever your pay period is, and extrapolate that out for the year to get your annual income. Also, if you have multiple forms of income or your income fluctuates, there are a few options:

  • Calculate from amounts on all of your 1099s and W-2s.
  • Bank statements for the last three to six months with consistent deposits.
  • Child support or alimony court orders.
  • Social Security benefits or pension statements.
  • Investment account official statement of income.

Once you have added up all of your debts as well as your gross monthly income from all sources, simply divide your debt by your income. A simple internet search will provide you with many sites that offer debt-to-income ratio calculators.

Good Debt-to-Income Ratio

Typically, auto loan lenders are looking for DTIs that are 36% or less, but there can be some room to negotiate. If you have a good credit score, a lender may look at higher DTIs of up to 48%, depending on the vehicle and the term you’re seeking. The DTI requirements may vary depending on refinancing an existing car loan versus applying for a new car loan.

Here is a breakdown of the various DTI ranges and how it is considered for your application:

  • DTI of 0% to 35%. This range shows your debt to be the most manageable. If you trend towards the upper end of this range, look for ways to pay down debt.
  • DTI of 36% to 49%. This range indicates you have your debt adequately managed, but you could be starting to have problems. In this range, you may want to consider credit counseling. There are a variety of nonprofits that offer low-cost or even no-cost debt solutions.
  • DTI of 50% or more. You should strongly consider seeking credit counseling or possibly even debt-relief options, including bankruptcy.

While DTI doesn’t affect your credit score, the individual items on your credit report do affect your DTI. Most creditors and lenders report your payments to the credit bureaus, which are used to determine your DTI.

Improving your DTI

You can do a few things to improve your DTI, and it is pretty straightforward. You could either pay down your debts, increase your income, or do both. There are many methods to pay down your debt quickly. One of those methods is the snowball method, in which you make extra payments to pay off your smallest debt and then take that extra amount and apply it to the next most significant debt balance. Continue this process until you have all debts paid off.

Decreasing your housing costs is another way to improve your DTI. Perhaps you could take on a roommate or downsize your living space and monthly rent or mortgage, depending on your situation. Also, increasing your income could be as simple as making money via a side job. You could also look into passive ways to make money, such as investments.

If you’re in the market for a new-to-you vehicle, reach out to the team at North Coast Auto Mall. We are a buy here, pay here dealership and can offer you various financing options regardless of your DTI. Stop by to see us at 1875 Brittain Road in Akron, give us a call at 330-752-8884, or fill out our convenient online form.

Posted in Car Financing