The next time you want to get an auto loan, be prepared to be asked for your most recent pay stub. Although the lender also will pull your credit score, your debt-to-income ratio will play a significant role in the loan decision. This establishes whether you can comfortably meet your monthly expenses when the auto loan is added to your monthly debt obligations. DTI should not be confused with debt-to-credit ratio, which is a credit utilization parameter on your credit report that indicates the amount of debt you carry in relation to your credit limits.
Typically, a good debt-to-income ratio is 36 percent or less.
Debt-to-Income Ratio Basics
Your DTI is a ratio of your monthly debt to monthly income. Before you hit the dealership or banking institution for financing, you can calculate your DTI on your own. Determine how much you spend on rent, student loans, credit card payments and any other installment or revolving loans. For DTI purposes, disregard variable expenses such as utilities, gas and groceries. Your monthly income comprises your earnings from all sources, before deductions. You also may calculate your total monthly income by dividing your annual gross income by 12.
Ideal DTI for Auto Loans
Your DTI represents your monthly income that goes toward paying the debt you owe, expressed as a percentage. Auto lenders routinely use the DTI to figure out the amount of loan you can handle after all your other monthly debts are paid. Typically, lenders want your DTI to be no more than 36 percent, inclusive of your monthly obligation for the auto loan you are seeking.
Working With Higher DTI
Suppose the car you want to buy will put you over the 36 percent mark. One option is to get a cheaper car. You could also increase the down payment so that your monthly payments are lower. Although stretching out the term of the loan also may lower your monthly payments and hence your DTI, you'll likely end up paying more than the car is worth down the line -- should you decide to sell it, you won't recover reasonable equity.
Lowering Your DTI
A good DTI can help you negotiate a better auto loan rate and amount even when your credit score is not favorable, because it indicates you are in a strong position financially. It's vital that you strengthen it before applying for the auto loan. You can significantly cut down your monthly commitments by paying down your credit card debt and other personal loans, refinancing your loans to get lower monthly payments, or go for debt consolidation. The other option is to increase your income -- take a part-time job, work some overtime, ask for a salary raise or generate some money from a hobby.
Dr Jack Gordon, the Chief Technology Officer at Strontium Logistics, is a 20-year veteran of the engineering and marketing business who favors stiff drinks, good debates and developing innovative digital marketing strategies to help companies grow.