You may want to buy a car, but are you truly ready to make the leap?
If the thought of financing a car makes your heart race and your palms sweat, you have good reason to feel that way: buying a car is one of the most significant purchases you’ll ever make.
Whether you’re new to the whole car ownership/adulting thing or if you’ve been around awhile, it helps to know the key benchmarks that help determine if you’re truly ready for the leap into car ownership.
Calculate your debt to income (DTI) ratio: Lenders rely on this figure when determining the level of risk involved in extending a loan. You can calculate your DTI ratio here. The lower your DTI ratio, the better your loan terms and interest rate will be.
Here is a breakdown of the DTI ratio ranges that most lending institutions and dealers rely on in deciding whether or not to grant a loan or extend any other offer of credit:
- 36% DTI ratio is ideal. You stand a better chance of getting the best loan amount, term, and interest rate for you.
- 37-42% DTI: Borderline high. You may end up with a higher interest rate or a lower loan amount.
- 43-49% DTI: High risk of default. Very few lenders would grant a loan to someone in this range. Expect to be saddled with a double-digit interest rate, and/or a high downpayment requirement if you’re granted a loan at all. Not worth it.
- >50% DTI: This is the “nope” zone for any lender.
Credit counts, too
Check your credit report: Another factor in determining overall creditworthiness is your credit profile and your credit scores. The three credit bureaus (TransUnion, Equifax, and Experian) will offer a free credit report to consumers through their websites.
In some cases, you’ll run into membership fees for extras such as credit monitoring, but unless you’ve been a victim of identity theft, come for the free credit report and stay for the FICO score (available at cost). Your credit score is one of the determining factors for a car loan.
Review your credit report and confirm that all of the information is correct, including the monthly payments on any active debt such as student loans. If you have any recent past due payments, collections, or public records, your chances of getting a decent car loan are slim.
If you notice any errors on your credit report, follow the procedure offered by the credit agency website. Expect to wait anywhere from 30-90 days for resolution depending on the nature of the error.
If your DTI ratio is good and if your credit is even better, get insurance quotes on the cars you’re interested in buying.You’ll avoid sticker shock and can factor the payments into your budget.
For example, I was floored to find it would cost me more to insure an 8 year-old Toyota Camry than it would to insure a 4 year-old Hyundai Elantra, mostly due to risk of theft in my community.
Insurance laws vary by state, so make sure you’re covered before taking your car off the lot. Investopedia has a great explanation of car insurance policies if this is an entirely new area for you.
Buying a car is a significant step whether you’re a first-time car buyer or an established car owner re-entering the market. By understanding the key components of buying a car, you’ll know whether or not you’re truly ready to take the leap into car financing and ownership.