When it comes to getting an auto loan, it takes more than just deciding you want another vehicle. If you have bad credit, it can be especially hard to know exactly what to look for when you're planning your car buying budget. No worries, we've got you covered!
More Than the Cost of the Car
There's much more to budgeting for an auto loan than just knowing what you can afford or how much the vehicle you want costs. When it comes to car loans, you have to take into account things like taxes, title and license fees, auto insurance, and interest charges – the real cost of borrowing money. Most people don't have enough cash laying around to just buy a vehicle outright, and that's where car loans come in.
The cost of financing depends on many things, including the vehicle you're planning to purchase and your credit score. The higher your credit score is, the lower the interest rate you're likely to qualify for. This means that when you have poor credit, it costs more money on average to borrow the same amount as someone with good credit.
This may not seem like a fair deal, but you can think of it as an incentive to keep your credit on track. If you're starting out with bad credit, you're not out of the running for an auto loan, but you do have more to think about when you're building your budget.
What Lenders Look for in a Borrower
When it comes to your budget, lenders are looking at your income and expenses to make sure that you're not already overextended. This is especially true of subprime lenders that work with credit-challenged consumers.
They do this by looking at two ratios: your debt to income (DTI) ratio and payment to income (PTI) ratio. These are two calculations that let you see how much of your budget is being used by your bills, and how much of your budget will be taken up by your combined car loan and insurance payments.
Subprime lenders typically require someone to have a DTI of 45% to 50% or less. When it comes to PTI, their threshold is generally 15% to 20% or less. Although, the lower your DTI and PTI, the better. You can calculate your ratios yourself to get an idea of what a lender sees when you apply for auto financing.
To calculate your DTI ratio, simply add together all your existing bills, loan payments, and estimated car loan and insurance costs for one month, and divide that amount by your pre-tax (gross) monthly income. The lower your DTI, the better off you are.
To calculate your PTI, you must add together your estimated monthly auto loan payment and your estimated monthly full coverage car insurance cost, and divide the sum by your gross monthly income. The resulting amount is a percentage representing how much of your income is being used by both your auto insurance and loan.
Making a Budget You Can Keep
Though finding your DTI and PTI ratios is a good first step to budgeting for your next auto loan, it's not the only thing you have to take into consideration. There are a number of other things that you also have to prepare for when you take out a loan.
Before you take out your next car loan, consider these costs:
- Vehicle cost – How much car you decide to finance is ultimately up to you, but your maximum loan amount is determined by your lender and your situation. Subprime lenders usually don't approve loans for less than $5,000.
- Interest rate – The higher your interest rate, the more money it costs you to finance a vehicle. When you have poor credit, your interest rate is likely to be higher than average, and may be in the double digits.
- Loan term – A short loan term can mean a high monthly payment. However, the longer you keep your loan, the more you pay in interest charges. It's good to balance your budget by taking out the shortest loan term you can with the highest payment you can comfortably afford.
- Down payment – Bad credit borrowers are required to make a down payment when taking out an auto loan. The exact amount varies by lender, but the typical down payment requirement is $1,000 or 10% of the car's selling price.
- Tax – Sales tax varies by state, and can raise the cost of your vehicle. It's a good idea to pay for your taxes up front when you take out an auto loan. They can typically be rolled into your loan, but you end up paying more in interest if you do.
- Title and license fees – The cost of plating and registering your car can be quite expensive in some states, but the regulations vary. Like taxes, it's often recommended that you pay these fees up front to avoid excess interest charges.
- Dealership fees – Also called documentation fees or "doc" fees, these can range from less than $100 to upward of $500 or more. This is what dealers charge for taking care of the paperwork involved in an auto loan. Some states cap the amount dealerships are allowed to charge, others don't.
- Fuel costs – No use having a vehicle if you can't afford to keep it on the road. Make sure you take the cost of gas into account before you buy.
- Maintenance – It's important to have cars serviced regularly, so that they can keep running smoothly. Oil changes, fluids, windshield wipers, filters, tires, brakes, and more can add up quickly.
- Repair costs – Another good rule of thumb is to have a rainy-day fund set aside for any unexpected vehicle repair costs.
- Full coverage insurance – When you finance a car, you're required to keep full coverage insurance on it until you pay off the loan. Full coverage is often more expensive than a state's minimum auto insurance coverage, depending on where you live.
Ready to Get Your Next Car Loan?
If you've got your budget in order, and are ready to take the next step in your car buying journey, CarsDirect wants to help. You can start by checking out our new and used vehicle pages, or jump right into the pre-qualification process by filling out our fast, free auto loan request form.
We'll then start the process of connecting you to a local dealer that's signed up with lenders that can work with people in many different credit situations. Don't delay, start today!
