FINANCIAL ADVICE | BUYING A CAr
How Much Car Loan Can I Get Approved For?
Published February 6, 2019
- First things first—you do not want to ask this question at the dealership.
- Your debt-to-income ratio (DTI) is a huge factor in how much loan you can afford,
- Your credit score is a number assigned to a person that indicates to lenders your capacity to repay a loan.
Frequently, a car is a person’s first major purchase. It’s exciting, especially with all the cool features you can get these days. Everybody knows that your car is like your clothes. It says something about who you are; so most of us aren’t inclined to grab the cheapest, most reliable thing on four wheels. But unlike clothes, most people have to borrow money to buy a car. So, before we start dreaming about what kind of car we want, we ought to explore the question: How much car loan can I get approved for?
First things first—you do not want to ask this question at the dealership. Dealers will not be concerned about how much you can actually afford; their goal is to sell you the most expensive car they can, because their commission rides on how much you spend. Though many of them will assure you they just like you so much, and want to help you get the best car, in fact they usually have very little interest in how this purchase will affect your life or ability to manage your finances in the future.
Instead, talk to a lender who is interested in how this purchase and loan will impact the rest of your life—because they want you to be able to pay them back. Credit unions generally have the lowest interest rates on auto loans, and because they are owned by their members, they’re very invested in making sure you don’t overextend on a loan.
So, yeah, the cherry-red Lamborghini might be out of range, but how can you figure out what amount you can qualify for? Here are some things to look at:
Figure Out Your Debt-to-Income
Your debt-to-income ratio (DTI) is a huge factor in how much loan you can afford, because it shows lenders whether you have enough money left at the end of the month to make a payment. DTI is calculated by adding up all your monthly expenses: rent or mortgage, student loan payment, credit card payments, other debt payments, and dividing the sum of those monthly debt payments by your monthly income. Debt/Income. Lenders want to see a DTI of 40% or less—the lower the better. The higher your DTI, the bigger the risk that you won’t be able to cover all those bills and you might fail to make payments or even default on the loan. Some lenders will still give you the loan, but they’ll charge you a lot more interest to account for the higher risk they’re taking.
So, one way to estimate how much of a loan you qualify for is to calculate how far you are from that 40%.
Monthly income: $8,000 (how much you earn every month, before taxes)
DTI 28% = $2,240 (how much you pay in current debt payments every month)
Now add 10% more debt to account for your auto loan, in this case $800 a month, which would bring your DTI to 38%. That’s still under the 40%.
So, if you paid $775 a month for 60-months at an average interest of 3.11%, then you could possibly qualify for a car of just over $40,000, plus taxes and interest.
Don’t forget to leave a little wiggle room for the interest the lender will charge depending on your credit score and the length of your loan.
Check Your Credit Score
Your credit score is a number assigned to a person that indicates to lenders your capacity to repay a loan. Many factors are considered in the estimation of the credit score including: your history with paying debts on time, past inquiries, total obligations outstanding, derogatory marks, credit card utilization, etc. If you have limited credit history, there are chances that your score is lower. On the other hand, if you have too much debt or don’t make timely payments, you’re likely to have a poor credit score for those things as well. Scores range from 300 to 850 but once you dip below about 680, you’re in higher risk territory and the likelihood of getting a loan goes down while the interest rates go up.
Determine Your Down Payment
The bigger down payment you can make, the less you have to borrow, the less lenders risk by lending you money. Of course, if you have a big down payment, you can afford a more expensive car, generally.
Let’s say your DTI calculation says you can afford a $450 payment.
For a 60-month loan, at 3.11%, not including taxes and interest, that’s a $25,000 car.
But, if you have $5,000 to put down, you could afford a $30,000 car. Or, you could get a $20,000 car and have a lower payment every month.
Buying Used? Loan-To-Value (LTV) May Matter Too
If the vehicle you’re purchasing is used or previously owned, the lender will also want to consider what’s called the Loan-to-Value ratio (LTV). In simple terms, your lender will crunch some numbers to make sure the loan you’re asking for is not outrageously higher than the value of the vehicle. Every lender has different LTV limits.
Ultimately this is in your best interest as the buyer, assuming you do not want to be upside down on a used vehicle for very long.
Estimate Your Interest Rate
Your interest rate impacts your car payment too, and your interest rate is determined by your credit score when you apply for the loan.
The lowest interest rates go to:
- Borrowers with excellent credit scores
- Borrowers with low DTI
- Borrowers buying newer vehicles
- Borrowers choosing shorter loan terms
Higher interest rates go to:
- Borrowers with credit scores in low ranges
- Borrowers with DTI at or over 40%
- Borrowers buying used cars
- Borrowers choosing longer loan terms
- Borrowers buying from private owners
To increase your chances of getting the loan you want, you can:
- Clean up your credit report
- Save for a down payment (so you can opt for a shorter loan term)
- Pay off debts
- Shop for last years’ new cars that haven’t been sold
- Make sure your trade-in vehicle is not upside down (worth less than the amount you owe)
Apply & Get Pre-Approved for Your Car Loan
Now that you’ve done your research and have an idea of how much of a car loan you can get pre-approved for, you’re ready to apply and get pre-approved. Or if you still have questions, give us a call at 214-818-3252.