Your debt-to-income ratio is a percentage that represents your monthly debt payments compared to your gross monthly 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 depends on the lender but — generally — the lower, the better.
Paying off debt can be challenging, especially when you have multiple debts. Knowing how much to pay off each debt can help create a plan. One method, the debt to income ratio, will help you define which debts to target first.
Now that you know what your estimated income is for the next 2 years, you can use this figure and the cost of the vehicle to calculate your debt-to-income (DTI) ratio. The important thing is to make sure you do not exceed the DTI limits set by the lending institution. Please note that auto financing companies measure your DTI on a monthly basis, so you will multiply the yearly amount by 12 and divide the auto loan amount by that amount.
Understanding your debt-to-income ratio (DTI) is key to understanding how much you can borrow for a car loan. A DTI less than or equal to 36% has been accepted by major lenders as a good benchmark for most people. However, your number can vary depending on several factors, particularly if you have an outstanding student loan balance (no pun intended) or other financing obligations like credit cards.
The debt-to-income ratio is a way of measuring your ability to pay back a loan. It’s calculated by dividing your total monthly debt by your gross monthly income.
To calculate your debt-to-income ratio for an auto loan, start by adding up all of the monthly payments you’ll have to make on the vehicle:
- The principal and interest payment on your car loan, which will be listed as “Principal & Interest” on your monthly statement from the lender
- The payment for any additional fees or taxes associated with owning a car, like registration or title fees (this amount will vary depending on where you live)
Then divide this number by your gross monthly income (the total amount of money you earn before taxes). This gives you an idea of how much money is left over each month after paying for essentials like food and shelter. If this number is higher than 35%, then it may be difficult for you to afford this new expense without taking on more debt than necessary.
What is a debt-to-income ratio?
The concept of a debt-to-income ratio is simple: monthly debt divided by monthly income. But there are two kinds of DTI ratios. Auto lenders will look at your back-end DTI, but we’ll explain both:
- Front-end DTI only accounts for monthly housing costs, including rent or mortgage, homeowners association fees, insurance and taxes. It doesn’t take into account other expenditures, such as payments on auto loans, student loans, personal loans or credit cards.
- Back-end DTI accounts for all your monthly debt payments. This could include other auto loans, alimony or child support, but it doesn’t include everyday expenses such as groceries or utilities. It also doesn’t include medical bill payments unless a collection agency becomes involved.
Both DTI calculations use gross monthly income rather than net monthly income. Gross income is what you make 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.
Payment-to-income (PTI) ratio: Some auto lenders will instead look at your PTI ratio because it’s simpler to calculate. To determine your PTI, divide your monthly car payment by your gross monthly income. According to the 20/4/10 rule, you should aim to have your transportation costs under 10% of your monthly income.
How to calculate debt-to-income ratio for car loans
Because auto lenders use back-end DTI, we’ll focus on that. To calculate your back-end DTI:
- Add up your monthly debt payments. If you don’t know what they are, look at your bank and credit card statements to find exact amounts.
- Look up your monthly gross income. If you’re salaried, you can take the annual amount and divide it by 12. If you’re paid hourly or work freelance, 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 income for one month’s worth of work. If you have fluctuating income and/or you have income from other sources, you could reference:
- 1099 or W-2 tax forms.
- Three to six months’ worth of bank statements showing steady deposits.
- Court orders for child support or alimony.
- Statements for Social Security benefits or a pension.
- Official income statements from investment accounts.
Once you have correct numbers for your total monthly debt payments and gross monthly income, divide your debt by your income.
DTI formula
Sum of monthly debt payments / sum of gross monthly income. (See an example, below.)
Debt expenses
Rent $900
Student loan payment $300
Credit card payment $125
Income
Salary $4,000
Part-time hourly work $800
The back-end DTI here is 0.276 — or 28%
What is a good debt-to-income ratio?
Lenders prefer to see DTI ratios below 36%, but there’s wiggle room.
Here’s a deeper dive:
- DTI of 0% to 35%: Your debt looks manageable. If your DTI is toward the higher end of this range, there are tips and tricks to pay down debt.
- DTI of 36 to 49%: Your debt management is adequate, but it could be causing you issues. 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: Strongly consider credit counseling and look into 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 affects 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 down your debts.
- Increase your income.
- Do both.
There are many ways to pay down debts, including the snowball method. This involves paying off the debt with the smallest balance, then taking the amount you were putting toward that debt on the next biggest balance – and so on and so on.
Another way to better your DTI ratio is to decrease your housing cost. Maybe a roommate or a smaller apartment would help you meet your goals.
To increase your income, you could make money with your car. There are potential opportunities for both passive and active earnings. You could also consider a side job.
Definition of Debt-to-Income Ratio
The debt-to-income ratio (DTI) is the sum of your monthly debt payments divided by your gross monthly income. In other words, what portion of your monthly income goes towards your loans and credit cards each month. DTI ratio gives lenders a view into your financial habits and can help them determine whether a loan approval for you is risky.
There are two types of debt-to-income ratio (DTI): front-end and back-end.
Front-End DTI and Back-End DTI
Front-end DTI only accounts for monthly housing costs; whereas back-end DTI, which is primarily what lenders focus on, includes all your monthly debt obligations. Back-end DTI includes all loan payments (e.g. student loan payments, mortgage payments, personal loans, auto loans, etc.), plus alimony, child support, and credit card payments. Neither back-end or front-end DTI includes everyday expenses such as utility bills, gym memberships, etc.
How to Calculate DTI
Use the following formula to calculate your DTI:
Monthly debt payments ÷ Monthly gross income = DTI ratio.
As an example, someone with a $1,000 mortgage, $500 car loan, and $500 in credit card debt who earns $6,000 in gross income has a DTI of 33%.
Their monthly debt payment is $2,000 ($1,000+$500+$500). The DTI is .33 ($2,000 $6,000). Multiply by 100 to get the percentage of 33%.
Effects of DTI on a New Auto Loan
When you submit a loan application, your DTI ratio and finances will be evaluated. In general, the lower the DTI ratio, the better chance a borrower has of qualifying for a new car loan. However, DTI is just one of several financial metrics used by dealerships, credit unions, and financial institutions when assessing your financial health. Your credit history and credit score are also key factors.
Following are the most commonly used DTI guidelines indicating a low, or good, debt-to-income ratio versus a bad or higher DTI ratio, typically indicating bad credit.
| DTI Ratio | Rating | Financial implications |
| 35% or less | Good | Debt is manageable, and you may be able to save money. Ideal range for a new car loan with the best loan terms. |
| 36% to 49% | Adequate | Most lenders cap DTI at 46%. With a good credit report, a new car loan is still possible. |
| 50% or higher | Bad or poor | Higher DTI limits your ability to get any loans. |
If your DTI ratio is less than favorable, there are steps you can take to improve your ratio, including reducing your total monthly debt payments by making larger monthly credit card payments to pay down the debt more quickly. You can also consider refinancing or debt consolidation to lower the interest rates on loans or credit cards.
The Right TDECU Car Loan for You
TDECU can help you find the new or used car loan that is right for you. Let us help make your car-buying process easy and hassle-free. We offer competitive interest rates, discounts, and flexible loan payment plans. Our convenient auto loan calculators help you compare auto loan rates and terms and protect your vehicle with our payment protection and insurance options.