Learn your limits when it comes to financing a car.
How do lenders determine my borrowing power?
Lenders consider your monthly living costs and weigh them against your monthly income to see whether you can afford to make your loan payments. However, it gets more involved when you start factoring in:
- Multiple incomes
- Credit card and loan debts
- People who are financially dependent on you
Another important factor that’s rolled in to how much you can borrow is your debt-to-income ratio. A good rule of thumb is that the debt you pay each month should account for no more than 36% of your monthly income — anything much higher may be seen as a red flag.
Note: If your calculation includes only minimum payments on your credit card(s), your debt-to-income ratio is actually higher than you figured. This is because minimum payments don’t show that you’re eliminating debt – just that you’re maintaining it. When looking at your finances, lenders are specifically looking to see how good you are at getting rid of debt. After all, they want you pay back your car loan, not struggle to make your payments.
When it comes to your vehicle, financial specialists recommend that no more than 10-15% of your monthly take-home pay should be used towards car expenses including principal payments, interest, insurance, gas and any other recurring car costs.
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What else should I consider?
You should also consider recurring monthly expenses before you apply for a loan in order to give yourself a detailed breakdown of your budget. This will help you figure out if you have room for another expense. Look at your personal finances, including:
- Essentials. Think about how much you spend on housing, food, utilities, commuting and other essentials you can’t live without.
- Extras. What do you spend when you go out to eat? Is shopping for clothes twice a month something you can give up? An ideal loan won’t require you to make significant lifestyle changes. If you’re stretching your budget, a loan may not be the right financial move.
- Costs of owning and maintaining a car. These include vehicle registration, licensing, insurance, gas, repair costs and countless other expenses. Leave yourself some financial leeway.
- Debts. Loan payments and credit card bills can add up each month. If they’re not taken care of when the bill is due, you could really damage your credit score.
How can I increase my borrowing power?
There are a few different ways to convince lenders that you’re capable of taking on a bigger loan, however, it may take some time and effort. A few strategies you can use to get a bigger loan in the future are:
- Spend less. Drawing up a budget and sticking with it can free up some cash flow and help you create less debt. And once your start spending less, you can take those savings and knock down whatever debt you’ve accumulated in the past.
- Improve your credit score. Paying bills on time, decreasing your debt-to-income ratio, using your credit card responsibly and correcting mistakes on your credit report can nudge your score in the right direction.
- Eliminate your debt. Cutting your debt minimizes your credit utilization ratio, showing lenders that you’re not desperate for a line of credit.
- Ask for a pay raise. Doing a great job at work and think you deserve a raise? Draw up a case as to why you deserve a pay increase. This extra bump will decrease your debt-to-income ratio and make you appear as a more attractive borrower.
- Compare. Every lender may look at your ability to borrow differently. This is why it’s extremely important to get a few quotes and do your research before moving forward with the first loan offer.
- Get a cosigner. A cosigner promises to take care of the loan if you default, increasing your borrowing power. Only ask someone to be a cosigner if you’re sure you’ll have no problem making the payments on your loan.
Remember to take into account all fees and taxes including the cost of the vehicle when determining how much you can spend on a car. Now that you know what to expect from lenders and what kind of borrowing power you have, you’re ready to compare compare car loans.
Frequently asked questions