Your debt to income (DTI) ratio helps a lender determine if you have enough available income to afford a bad credit auto loan. Shown as a percentage, this is a calculation you can do yourself. Having a DTI ratio that falls within the lender’s range is important when applying for a car loan; if your DTI ratio is too high, you may not qualify.
Calculating Your Debt to Income Ratio
If you’re dealing with bad credit, you’re going to want to work with a subprime lender. These lenders work with special finance dealerships, and are often able to approve borrowers struggling with credit issues.
In determining if you qualify, they’re going to “debt you out,” also known as calculating your DTI ratio. It’s important for you to calculate your DTI ratio first, so that you can make sure yours isn't so high that you can't afford a loan.
Ideally, your DTI ratio, including an auto loan and insurance payments, should be no more than 45% to 50% of your gross monthly income. If it’s any higher, you run the risk of being turned down for subprime car financing. Lenders want to make sure you have enough money to afford a vehicle on top of your current bills.
To calculate your DTI ratio, simply add up all your monthly bills (including an estimated auto loan and insurance payment) and divide the total by your gross (pre-tax) monthly income. So, if all your bills add up to $1,400 each month and your monthly pre-tax income is $4,000, your DTI ratio would be 35% (1,400 divided by 4,000 equals 0.35, or 35%).
Payment to Income Ratio and Other Factors
Your DTI ratio is important, but what about your payment to income (PTI) ratio? Your PTI ratio determines your maximum car payment, and, just like your DTI ratio, you can calculate it ahead of time.
To find it, all you have to do is take your gross monthly income and multiply it by 0.20, or 20%. Subprime lenders typically cap your PTI ratio at 20%. For an example, let’s use the same numbers as above: $1,400 in monthly bills and a pre-tax income of $4,000. In this case, your max vehicle payment should be no more than $800 (4,000 multiplied by 0.20 equals 800).
Once you determine your PTI and DTI ratios, it’s time to plan your budget – this means considering items outside of the selling price, such as interest rate, loan term, and fuel and maintenance costs.
This is especially important if you’re getting a bad credit auto loan, as your interest rate is likely to be higher than average, which may increase the overall cost of the loan to beyond your PTI ratio cap.
On top of interest, the loan term affects the overall cost. It’s true that the longer the loan, the lower the monthly payment. However, you pay more in interest charges as the loan term increases.
As for car insurance, you must carry the minimum full coverage amounts required by your lender – and this is never cheap.
The Bottom Line
Make sure you calculate your DTI and PTI ratios before you head to a dealership. The lender is going to calculate these for you, but knowing your financial situation ahead of time can help you get an idea on how much vehicle you can afford.
When you’re ready to find a dealer to work with, The Car Connection is here to assist. We work with a nationwide network of dealerships that have the lending specialists you're looking for if you need a bad credit auto loan.
Simply fill out our easy, fast, and free car loan request form today, and we'll start the process of matching you with a local dealer. Don't wait any longer – get started now!