Your borrowing power is how much money you can borrow without putting too much pressure on your finances. Here we guide you through how to work out your car loan affordability and how lenders determine your borrowing limit when you apply.
Why is it essential to understand your borrowing power?
When you apply for credit, such as a car loan, the lender lists it on your credit report, and this happens whether you receive approval or not. If there are several enquiries for finance on your credit report, it can be a red flag to lenders and can stop you from receiving approval for loans.
Understanding your borrowing power can help you limit the number of applications and enquiries you need to make, as you will only apply for loans that you can afford. It’s essential to compare many offers, but you don’t want to apply for too many different loans. You also don’t want to damage your credit history by any rejections you receive.
Calculate your car loan borrowing power
You can use the calculator below to get an idea of your borrowing power.
How do lenders determine your borrowing power?
Most lenders use Debt to Income (DTI) ratios to determine your borrowing power, which is the closest thing to a one-size-fits-all approach to calculating these factors. It involves adding up all your monthly debt payments and dividing them by your gross monthly income. This gives a percentage figure that a lender will use as an indication of how much to lend you.
Traditionally a debt-to-income ratio of 28% is seen as a ‘good’ DTI while a ratio of 37-43% is seen as a ‘high’ DTI ratio.
How to work out your monthly expenditure
When you apply for a loan, your lender typically requires your monthly expenditure, despite them also making their own calculations. For car loan affordability, most lenders require a single figure, but others might want a more detailed cost breakdown.
- Consider how much you spend on essentials, which includes housing, food, utilities, transport and other things you can’t live without.
- Factor in how much you tend to spend on discretionary costs and luxuries each month. Resist the urge to exclude these from your calculations. An ideal loan doesn’t require you to make significant lifestyle adjustments, although this isn’t always possible.
- Remember to consider the cost of owning and maintaining a car. There are numerous one-off expenses, plus ongoing costs. These include vehicle registration; licensing; insurance (not compulsory but recommended); petrol; repair and maintenance costs and many others. However, do not add these into your monthly expenditures unless you already have and pay for a different car, because your lender factors them in for you. However, do bear this in mind, and leave yourself some financial leeway for the costs.
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