When you start shopping for a new car, you may envision yourself driving a big, shiny, new vehicle loaded with all the latest features. Before you make a list of all the bells and whistles you want on your vehicle, though, you better first look at how much you can afford to pay each month on a car payment. One way to determine how much you can pay for a new car is to calculate your debt-to-income ratio.
Definition of Debt-to-Income Ratio
The debt-to-income ratio (DTI) is the sum of your monthly debt payments divided by your gross monthly income. In other words, what portion of your monthly income goes towards your loans and credit cards each month. DTI ratio gives lenders a view into your financial habits and can help them determine whether a loan approval for you is risky.
There are two types of debt-to-income ratio (DTI): front-end and back-end.
Front-End DTI and Back-End DTI
Front-end DTI only accounts for monthly housing costs; whereas back-end DTI, which is primarily what lenders focus on, includes all your monthly debt obligations. Back-end DTI includes all loan payments (e.g. student loan payments, mortgage payments, personal loans, auto loans, etc.), plus alimony, child support, and credit card payments. Neither back-end or front-end DTI includes everyday expenses such as utility bills, gym memberships, etc.
How to Calculate DTI
Use the following formula to calculate your DTI:
Monthly debt payments ÷ Monthly gross income = DTI ratio.
As an example, someone with a $1,000 mortgage, $500 car loan, and $500 in credit card debt who earns $6,000 in gross income has a DTI of 33%.
Their monthly debt payment is $2,000 ($1,000+$500+$500). The DTI is .33 ($2,000 $6,000). Multiply by 100 to get the percentage of 33%.
Effects of DTI on a New Auto Loan
When you submit a loan application, your DTI ratio and finances will be evaluated. In general, the lower the DTI ratio, the better chance a borrower has of qualifying for a new car loan. However, DTI is just one of several financial metrics used by dealerships, credit unions, and financial institutions when assessing your financial health. Your credit history and credit score are also key factors.
Following are the most commonly used DTI guidelines indicating a low, or good, debt-to-income ratio versus a bad or higher DTI ratio, typically indicating bad credit.
DTI Ratio | Rating | Financial implications |
35% or less | Good | Debt is manageable, and you may be able to save money. Ideal range for a new car loan with the best loan terms. |
36% to 49% | Adequate | Most lenders cap DTI at 46%. With a good credit report, a new car loan is still possible. |
50% or higher | Bad or poor | Higher DTI limits your ability to get any loans. |
If your DTI ratio is less than favorable, there are steps you can take to improve your ratio, including reducing your total monthly debt payments by making larger monthly credit card payments to pay down the debt more quickly. You can also consider refinancing or debt consolidation to lower the interest rates on loans or credit cards.
The Right TDECU Car Loan for You
TDECU can help you find the new or used car loan that is right for you. Let us help make your car-buying process easy and hassle-free. We offer competitive interest rates, discounts, and flexible loan payment plans. Our convenient auto loan calculators help you compare auto loan rates and terms and protect your vehicle with our payment protection and insurance options.
Whatever your transportation needs, TDECU can help you find the auto loan that is right for you. Contact us today!