Lenders that work with bad credit borrowers want to make sure that you don't go broke paying for a car loan. To do this, they look at your monthly income and monthly bills when considering you for financing. We explore the typical income requirements for a car loan, including the minimum income qualification and the debt to income and payment to income ratio requirements. You should know how these work so you can see for yourself if you have enough available income for an auto loan.
Your Budget is Important
When you finance a car, there's more involved than the numbers on the window sticker. Lenders know that the negotiated price of your vehicle is only the beginning, so they want to make sure you have enough available income to afford an auto loan and successfully pay it off.
Your success with a car loan is just as important to lenders as it is to you. Why? If you default on your loan, you lose your vehicle and whatever money you've already put into it. But your lender is losing out, too.
Cars that are repossessed, which typically happens when you default, are usually sold at auction far below their current wholesale value. This means the lender loses money on the sale of the vehicle. Plus, it costs them to hire a recovery company to come and get your car, store it, and send it to auction.
Right now, repossession may be happening rapidly, since inventory is so tight on used cars, so it's important to communicate with your lender before you default on your car loan. It’s really in your lender’s best interest to determine a payment that works for you, to help avoid a default that hurts everyone involved.
How Do Lenders Evaluate Your Income?
When you're taking out a bad credit auto loan, there are certain minimum income requirements you have to meet. This includes a minimum monthly income requirement and having an acceptable debt to income (DTI) and payment to income (PTI) ratios.
Generally, subprime lenders require you to make at least $1,500 to $2,500 a month before taxes from a single income source. If you meet this minimum income requirement, lenders then determine if you have enough income to comfortably pay your car loan by calculating your DTI and PTI ratios.
The DTI and PTI ratios are two things that let a lender find a car that fits your budget. Your DTI ratio compares your total pre-tax income to your existing bills, while your PTI ratio lets lenders see how much of your available income would be used for your auto loan and car insurance payments combined.
Subprime lenders typically cap your DTI ratio at 45% to 50% of your monthly income, while they generally require PTI ratios to be no more than 15% to 20% of your earnings.
Calculate Your Car Buying Budget
Now that you know what lenders are looking at for income, you need to know how to calculate these ratios yourself so that you're prepared going into the car buying process.
To calculate your DTI ratio, simply add up all your existing bills and payments, including an estimated car loan and insurance payment, and divide that by your gross monthly income. If you get a percentage less than 45% as your answer, you should be in good shape for an auto loan.
For example, if your existing rent or mortgage, credit cards, bills, loans, car payments, and insurance cost you $850 a month, and your pre-tax monthly income is $2,800 a month, you have a DTI ratio of 30% (850 divided by 2,800 equals 0.30, or 30%), which fits a lender's typical DTI ratio requirement.
To calculate your PTI ratio, add up your estimated auto loan and insurance payments and divide that by your gross monthly income. Keep in mind that lenders estimate your car payment, which you can do with an estimated payment calculator. They also generally use an estimate of $100 as a monthly insurance cost, just to be on the safe side.
For example, let's say your combined auto loan and insurance payment is $400. Divide this by your income of $2,800, and you can see that your monthly car and insurance payment accounts for 14% of your monthly income (400 divided by 2,800 equals 0.14, or 14%).
TCC Tip: When you're considering your next auto loan, remember that you have to account for things like gas and maintenance costs, so you should allow room in your budget for both. The further away from the lender’s maximum DTI and PTI ratio caps you are, the more room you’re leaving in your budget for these other costs of car ownership.