A debt to income (DTI) ratio is one way lenders determine if you have enough available income to afford a car loan. Your DTI ratio is important to know because lenders won't approve you for an auto loan if it's too high. Thankfully, it's easy to calculate for yourself.
Debt to Income and Available Finances
The reason your debt to income ratio is important is because bad credit lenders genearly cap your maximum DTI ratio at 45% to 50% of your pre-tax income.
This means if your existing bills – plus an estimated car loan and insurance payment – total more than half of your gross (pre-tax) monthly income, you aren't getting approved. Lenders want you to be able to comfortably afford a vehicle. Without enough available income, you're not going to be able to do that.
Remember, there's more that goes into car buying than the price of the vehicle. You have to consider the cost of maintenance, fuel, and insurance – items that you can't afford without enough available income. When you buy a car, it's important that you put together a budget and stick to it, especially if you have bad credit.
Determining Your Debt to Income Ratio
To determine if you have enough available income to begin shopping for your next auto loan, you calculate your debt to income ratio by adding up your existing bills, and dividing the total by your gross monthly income. The resulting number is a decimal representing the percentage of debt you're already using. Personal and incidental items, such as groceries, don't need to be included when calculating your DTI ratio.
For example: When your rent ($500), potential vehicle payment ($375), car insurance ($100), and minimum credit card payments ($200) add up to $1,175 each month, and your gross monthly income is $3,200, your DTI ratio is approximately 37%. You find this by dividing $1,175 by $3,200 to get 0.367, or 36.7%.
In this case, you now know that your debt to income ratio falls below the typical maximum allowed DTI ratio for a bad credit auto loan. However, this is just the tip of the budgeting iceberg.
Other Budgeting Factors to Consider
In order to truly see how much you can afford for a car loan, you should also take into consideration how much of your income is needed for your vehicle payment.
Using the example above, we can see that a car payment of $375 a month is approximately 12% of your available income. We find this out by dividing the vehicle payment by your gross monthly income: 375 divided by 3200 equals 0.117, or 11.7%.
This is called your payment to income (PTI) ratio. Bad credit lenders typically don't allow a car payment to exceed 15% to 20% of your gross monthly income, but the lower the better.
Now that you are aware of the DTI ratio and PTI ratio guidelines, you should also consider things like loan term, interest rate, and insurance costs. When planning your auto loan budget with bad credit, remember you're going to have a higher than average interest rate due to your credit issues.
Because of this, you need to carefully consider how long your loan should be. Sure, an 84-month loan might make your monthly payment more affordable, but do you really want to be making payments on a vehicle for seven years? Plus, the longer you stretch your loan term, the more you end up paying in interest charges.
As for insurance costs, you're required to carry full coverage insurance while you're financing a car. Full coverage differs from the minimum amount of coverage determined by the state you live in, and it could be much higher than what you're used to paying if you don't have a full coverage policy now.
Finding a Dealer to Work With
Now that you know you can put together a budget with a few simple calculations, you should also look at the size auto loan you might be eligible for with the help of online tools such as our Car Loan Estimator.
Remember, these tools only give you a rough estimate based on input you use – such as credit score, interest rate, and loan term – so it's important to be as accurate as possible if you want a realistic estimate. Actual loan terms vary by lender.
Speaking of lenders, you may find your best luck getting approved for an auto loan with bad credit if you explore financing through a subprime lender. These lenders work through special finance dealerships, but not all dealers use subprime lenders. To find a special finance dealership in your area, why not fill out our fast, free, and easy car loan request form?
Here at Auto Credit Express, we work with a nationwide network of special finance dealers that have the lending resources you need if you have bad credit, no credit, or even a bankruptcy. Don't delay any longer, get the process started right now!