Instead of playing a guessing game when you sit down with a finance manager at a dealership, start your car loan off on the right foot by calculating your budget from the start! Overextending yourself just to get a vehicle isn't a great choice, especially if you have bad credit.
Knowing What to Budget For
When you're budgeting for your next auto loan, it's important to know that you can financially handle it. In order to do this, you can do the same calculations that lenders do when they're evaluating your car loan application.
Firstly, you need to know that you make enough money to meet the lender's minimum requirement. This is generally $1,500 to $2,500 a month from a single income source, but it varies by lender.
Then, you have to make sure that too much of your monthly income isn't already being used by your existing monthly bills. Lenders do this by calculating your debt to income (DTI) ratio. Before you begin doing math problems, though, remember that an auto loan itself is only half the equation.
Let's take a deeper look at some things that go into budgeting for a car loan:
- Debt to income ratio – Your DTI ratio let's a lender know how much of your available income is already being used by you existing bills. An auto loan doesn't do you any good if it makes you go into more debt, so bad credit car lenders typically cap your usable DTI ratio at 45% to 50% of your income. To calculate this, add together all your bills including an estimated auto loan and insurance payment, and divide the sum by your pre-tax monthly income. If you get a percentage less than 45% or 50%, then you meet the typical DTI ratio criteria.
- Payment to income ratio – The payment to income (PTI) ratio calculation let's you see how much of your monthly income is being taken up by your monthly vehicle and insurance payments. This is generally capped at 15% to 20% of your income. To calculate this yourself, the simplest way is to multiply your pre-tax income by 0.15 and then again by 0.20. The totals you get represent the top of your budget when it comes to a car loan and insurance payment. If you're not sure what to use as an average insurance payment, since it can vary depending on vehicle, lenders typically estimate the cost at $100 per month.
- Tax, title, and license fees – There's no particular formula for calculating your tax, title, and license fees. However, these are things that aren't included in your standard auto loan calculation. These items are typically due at signing, and should be paid up front and out of pocket in order to avoid interest charges that accrue when you roll them into your loan.
The Car Connection Tip: Don't forget that things like the cost of maintenance and fuel should be budgeted for as well. These additional costs should be taken into account when you're considering a vehicle.
What if Your Car Loan Budget Isn't Up to Par?
If your budget isn't ready to take on the strain of a car loan, but you need another vehicle now, you may still have some options to consider:
- Making a bigger down payment. The more money you can put down on an auto loan, the less you need to borrow. If you're stretching your budget trying to afford a car loan, you may be able to increase the amount of your down payment by using the equity in your current vehicle to meet or excess your down payment requirement. Regardless of the amount of your loan, you still need to meet DTI and PTI ratio qualifications. If there isn't any wiggle room in your budget, you may need to wait or free up some money by scaling back in other areas.
- Sign up with a co-borrower. A co-borrower is typically a spouse or life partner that signs the auto loan with you. To do this, lenders make sure both of you qualify creditwise, and combine your incomes when making calculations. This means working together with someone on a loan, though. You're both responsible for the payments and maintaining full coverage car insurance, and both of your credit scores are affected by how the loan is handled.
- Try for a lease takeover. If you're looking to drive something new and meet all the lease qualifications, you may be able to assume someone else's lease. Also known as a lease takeover, this can give you the ability to get a new vehicle to drive for a while until the term is up. Leases retain their original terms and conditions when you take them over, so you're expected to adhere to them and can't negotiate for anything different. Assuming a lease also means taking responsibility for any overages or damages at lease turn-in time.
- Opt for a rent to own car. A rent to own, or lease to own, program is often a last resort option for people with bad credit. This may be where to turn if you've been denied a subprime loan. A rent to own car lot only provides used vehicles, and you may need to make a payment every week or two instead of monthly. The lender usually holds the title of the car until you finish paying off the loan, but the unique feature of a rent to own vehicle is that you can usually back out of the deal at any time. All of your previous payments are considered rental fees and are nonrefundable. This can be an expensive option in the long run, but may work if you need a car quickly.
- Wait it out. If none of these options seem feasible in your situation, it's OK to wait it out until you have more room in your budget. Try paying off debt and consolidating bills while you do so. Cut down on unnecessary spending like expensive coffee and subscription services you barely use. These habits can be a good way to save for an auto loan, free up your budget, and may even help your credit score improve.
When You Can Afford it, We're Here to Help
Once you're at a point where getting your next car loan comes down to credit score – not budget – we've got you covered. At The Car Connection, we work with a nationwide network of special finance dealerships that have lending resources for people in many credit situations.
We want to assist you by connecting you to a dealer in your area. The process is simple, fast, and free. Just fill out our no-obligation auto loan request form to get started toward your next vehicle.