Your debt to income (DTI) ratio will effect if you can get approved and how much you can get approved for. Your DTI ratio shows a lender how much money is currently coming out of your pocket based on loans, rent, and other things that show up on your credit report as payments that you make. This doesn’t include items like your utility bills, phone, or insurance payments.
All of your qualifying payments are added together and compared to your monthly income to see what percentage of your income is tied up into those payments. For example, if your rent, credit card, and personal loan payments total up to $750 and your monthly gross (before taxes) income is $1700 then your DTI ratio would be calculated as follows: $750/$1700 = 44%. That means that 44% of your income is going to expenses before they add in the new car note you are trying to get. That’s almost half of your income already!
Most lenders will look at that number as too high and will probably decline you because the car note will raise your DTI ratio past 50% of your income. With only a $200 car note added to that situation, your DTI ratio would be 55%. A good DTI ratio and also the average ratio lenders want you to have is around 35%. That’s including the payment on the auto loan you’re trying get.
Using the previous situation with an income of $1700 monthly you want to find out what amount your car payment would need to be to get approved. To do that just multiply 35% by your income $1700. That would show you the total amount of expenses you can afford as follows: $1700 x 35% = $595. So in this situation, your new car note plus your current expenses are limited to a total of $595 in order for you to get approved with $1700 monthly gross income.
Remember, your current monthly expenses are total $750. That includes rent, credit card, and personal loan payments. So if your rent is $400 that means you would need to pay off your credit cards and personal loan to cut down your expenses by $350 monthly. Then you would have $195 ($595-$400) available to use for a new car note.
As you can see your current income obligations and the new car note need to play well together before a lender will approve you. There are some other ways to lower your DTI ratio so you can get the car you want and they all include methods that lower the amount of your new car payment. You can put more money down on the car, trade in your old car, or increase the number of years you set the loan for. However, increasing the years on the loan will cause you to pay way more money for the car in the long run.
The best thing you can do to lower the car payment is to make sure you get a low-interest rate. The interest rate will have the greatest effect on how much your monthly payment is and how much you pay for the car in the long run. The only way to get a lower rate is to make sure you have your credit report and credit score in the best condition possible before you apply for the car loan.
You can check your credit score here with identity IQ for $1 if you want to see where you stand before you hit the dealerships.
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