Your debt-to-income ratio is a percentage that represents your monthly debt payments compared to your monthly gross income. Auto lenders use this ratio, also known as DTI, to judge whether you can afford a loan payment. Whether you have a good debt-to-income ratio for a car loan is up to the lender, but generally, the lower the better.
what is a debt-to-income ratio?
The concept of debt-to-income ratio is simple: monthly debt divided by monthly income. but there are two types of dti relationships. auto lenders will look at your dti back-end, but we’ll explain both:
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- initial dti represents only monthly housing costs, including rent or mortgage, homeowners association fees, insurance, and taxes . it does not take into account other expenses, such as car loan payments, student loans, personal loans, or credit cards.
- back-end dti accounts for everyone the monthly payments of your debt. This could include other auto loans, alimony or child support, but does not include everyday expenses like groceries or utilities. it also does not include payment of medical bills unless a collection agency is involved.
both dti calculations use gross monthly income instead of net monthly income. Gross income is what you earn before taxes or deductions, such as income taxes, social security contributions, and deductions for health care and retirement. Auto loan applications will generally require you to list your annual income, other sources of income, and assets.
how to calculate debt-to-income ratio for car loans
since car lenders use back-end dti, we will focus on that. to calculate your backend dti:
- Add up your monthly debt payments. If you don’t know how many, check your bank and credit card statements to find the exact amounts.
- find your monthly gross income. if you are salaried, you can take the yearly amount and divide it by 12. if you are paid hourly or self-employed, find your total income on your w-2 or 1099 forms and divide by 12 months.
If you don’t have these forms available, look closely at your pay stubs and add up your gross earnings for one month’s worth of work. If you have fluctuating income and/or have income from other sources, you can refer to:
- 1099 or w-2 tax forms.
- three to six months’ worth of bank statements showing stable deposits.
- Court orders for child support or alimony.
- statements of social security benefits or a pension.
- official statements of income from investment accounts.
Once you have the correct numbers for your total monthly debt payments and gross monthly income, divide your debt by your income.
what is a good debt-to-income ratio?
Lenders prefer to see dti ratios below 36%, but there is wiggle room.
here’s a deeper dive:
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- dti from 0% to 35%: your debt seems manageable. if your dti is at the higher end of this range, there are tips and tricks for paying off debt.
- 36-49% dti: your debt management is adequate, but it could be causing you problems. you might consider credit counseling. nonprofit organizations like the national foundation for credit counseling (nfcc) offer free or low-cost solutions.
- 50% or more dti: seriously consider counseling credit card and explore debt relief options.
does your dti affect your credit score?
no, your dti doesn’t affect your credit score, but what’s on your credit report does affect your dti. Lenders and creditors report your payments, which are used to calculate your DTI, to the credit bureaus.
how to improve your dti
To improve your dti, you could:
- pay your debts.
- increase your income.
- do both.
There are many ways to pay off debt, including the snowball method. this involves paying off the debt with the smallest balance, then taking the amount you were putting toward that debt into the next largest balance, and so on.
another way to improve your dti ratio is to lower the cost of your home. maybe a roommate or a smaller apartment would help you reach your goals.
To increase your income, you could earn money with your car. there are potential opportunities for passive and active earnings. you could also consider a side job.
