Debt-to-income ratio, or DTI, measures your total monthly debt against your total monthly income. Along with your credit score, lenders use your DTI to judge whether they will offer you a loan and if so, at what rate.
Debt-to-income ratio for car loans is represented by a percentage. Generally, the lower this percentage is, the more creditworthy you are. The more creditworthy you are, the lower your rates may be.
When you apply for an auto loan, the lender will check your DTI. Specifically, it wants to make sure that you can cover an additional loan after you’ve paid your current debt obligations.
There are two kinds of DTI ratios: front-end DTI and back-end DTI. Auto lenders look at back-end DTI.
- Front-end DTI focuses only on your monthly housing costs. These could include rent or mortgage payments, homeowners association fees, property insurance and taxes.
- Back-end DTI focuses on all of your monthly debt, not just housing. This could include your mortgage as well as auto loans, student loans, personal loans and credit cards. It does not include daily expenses such as groceries, utilities or medical bills (in many cases).
What is payment-to-income ratio (PTI)?
Instead of DTI, some auto lenders use PTI, or payment-to-income ratio. Your PTI measures your car payment as a percentage of your income. To calculate your PTI, divide your monthly car payment by your monthly gross income.
If you follow the 20/4/10 rule, your total transportation costs should only account for up to 10% of your income. However, lenders set their own PTI minimum requirements.
How to calculate debt-to-income ratio for car loans
DTI is simple to calculate — just divide your total monthly debt payments by your gross monthly income. Gross income is what you earn before taxes and other deductions. Since auto lenders consider your back-end DTI, that’s what we’ll focus on.
You’ll need two things to calculate your back-end DTI: your total monthly debt payments and your gross income.
First, add up your monthly debt payments. If you don’t know what they are, add up the minimum monthly payments shown on your credit card statements and other debt bills. You could also check your banking history to see what you pay each month.
Then, calculate your gross income. If you’re salaried, take your annual income amount and divide it by 12. If you’re an hourly or freelance worker, find your total income on your W-2 or 1099 and divide it by 12.
If you have fluctuating income or income from sources other than employment, you could also reference:
- Three to six months’ worth of bank statements showing steady deposits
- Statements for Social Security benefits or a pension
- Income statements from investment accounts
Additionally, auto loan applications may ask whether you’d like to include child support or alimony as income. If you do, be prepared to show court orders that reflect what you get paid.
DTI formula
To find your back-end DTI, divide the sum of your monthly debt payments by the sum of your gross monthly income. (See the example, below.)
Debt expenses
Rent $900
Student loan payment $300
Credit card payment $125
Income
Salary $4,000
Part-time hourly work $800
Add up your monthly debt expenses ($900 + $300 + $125) to get $1,325. Divide $1,325 by your monthly income, $4,800 ($4,000 + $800). This comes out to 0.276. Converted to a percentage, your back-end DTI is 28%.
If you don’t want to do the math, you could also use a debt-to-income ratio calculator.
Most lenders consider anything below 36% to be a good debt-to-income ratio, but you could have wiggle room. DTI thresholds vary by type of loan and by the lender itself. Still, you’ll find some general guidelines below.
DTI of 0% to 35%: Your debt looks manageable. If your DTI is on the higher end of this scale, you may want to look into ways to become debt free.
DTI of 36% to 49%: Your debt may be becoming hard to handle. You could consider credit counseling. Nonprofits such as the National Foundation for Credit Counseling (NFCC) offer no- or low-cost solutions.
DTI of 50% or more: Your debt is probably unmanageable, it may be time to explore debt relief options. At this stage, it will be hard to find a lender that will approve you.
Does DTI affect your credit score?
No, your DTI does not affect your credit score. However, some of the information on your credit report affects your DTI. Most lenders report your payments to the credit bureaus. These payments are used to calculate your DTI.
How to improve your debt-to-income ratio
If your DTI ratio is above 43%, you may need to limit your search to bad credit car loans. But even if you are approved for a car loan, continue to work on your DTI. By improving your DTI (and credit score), you may be able to refinance your auto loan for a better rate later on.
Pay down your current debts
Paying off some of what you currently owe is essential for improving a high debt-to-income ratio. It can seem impossible to pay down debt when you’re on a shoestring budget, but some strategies may help.
For instance, if you use the debt snowball method, you’ll prioritize paying off your smallest debts first. This can provide the psychological boost you need to continue paying off your debts one by one.
The debt avalanche method, on the other hand, will direct your attention to your debt with the highest interest rates. Tackling your high-interest debt first can help you pay less interest over time.
Avoid taking on new debt
If you do qualify for a loan with a high debt-to-income ratio, it still may be worth waiting until your DTI is better under control. Applying later with a better DTI ratio could help you gain access to lower APRs.
Increase your income
It’s easier said than done, but increasing your income can help tip the DTI balance in your favor. Remember that your full-time job isn’t the only income that counts.
You could take on a side hustle or find other ways to earn extra cash. Just know that this income will need to be consistent before a lender will consider it as income.
