A budget is one of the most important financial tools you can have. When it comes to planning a big purchase, such as a car, it becomes even more important. If you need to finance a car with less than perfect credit, you'll find that budgeting for your car loan is especially valuable.
Why Budgeting for Your Bad Credit Auto Loan Matters
Poor credit auto loans have careful income requirements in place to qualify applicants. In addition to needing to be able to prove you earn a minimum monthly income (typically around $1,800 a month before taxes are taken out), you also need to meet their debt to income and payment to income ratio standards.
When it comes to qualifying for bad credit car loans, it's not always about how much you make. What's left over after you pay your bills every month is also very important. This is where the debt to income (DTI) ratio comes in.
Your DTI ratio is simply the amount you pay in monthly bills divided by your monthly pre-tax income. Lenders typically set the maximum DTI they are willing to accept at around 45-50% of your total income, and this includes adding the potential car and insurance payment into the mix.
You can easily calculate yours before applying. You just need to add up all your monthly expenses (rent, mortgage, credit card payments, loan payments, average utility bill payments, etc.) and divide it by your total monthly income before taxes are taken out.
At the same time, lenders will also be concerned with your payment to income (PTI) ratio. This figure represents what percentage of your income a potential car and insurance payment will take up. Lenders typically cap your PTI ratio somewhere between 15-20% of your total monthly income.
As an example, for someone who earns $2,200 a month, the monthly car and insurance payment combined could not exceed $440 ($2,200 multiplied by 0.20). You can calculate this on your own by taking your monthly income and multiplying it by 0.20.
Figuring Out Your Car Buying Budget
You should be tracking your spending already, because budgeting makes your financial life easier. If you aren't, and are planning to finance a car, there's no shame in starting now.
So, start with the exact amount you are bringing in each month. Then, start listing your monthly expenses. These include your mortgage or rent, credit card payments, loan payments, utility payments, food and groceries, clothing, personal care items, how much you are putting into savings, and whatever else you routinely spend money on. Here's a great example of a personal budget.
It's a great idea to write this all out, whether on a document on a computer or by hand. Others find it helpful to literally track every single dollar they spend over the course of a month (or a few months) to give them accurate figures. Others find it simpler to place things into general categories instead of individually listing everything. The point being, there are many different successful ways to map out your budget, so keep adjusting until you find a way that works for you.
When you know what you are spending each month, you can then subtract that figure from your income. What's left over is your disposable income. This will give you an idea of what you can spend on a car payment.
But it's important to remember that you need to stay well below this figure. For starters, you need to leave some wiggle room in your budget because life is unpredictable. Also, there are other expenses of car ownership that you need to account for. As we discussed with the ratios above, you need to account for your monthly insurance payment, as well. In addition, you can't forget about fuel, maintenance, and repairs either.
The Bottom Line
Getting your budget in order will help you tackle the car buying process with more confidence. And knowing how lenders calculate DTI and PTI will help you get a closer look into your chances of qualifying.
But often the hardest part of qualifying for a bad credit auto loan is finding a dealership that can work with your situation. We've solved that problem at Auto Credit Express with our nationwide network of special finance dealerships.
Using our free and no-obligation service, we can help you find a local dealership that can handle unique credit situations. Get started today by filling out our simple and secure online auto loan request.