Buying a car when you have student loans is pretty similar to buying a car any other time.
You still spend the time looking at cars, test driving them, and negotiating with the seller. You decide whether to buy new or used; to lease or buy; to get a sports car or a family car. But the key difference is this: you always have to factor in your student debt when thinking about how much car you can afford.
No matter what your finances look like, you must be honest with yourself about your situation and decide which kind of car is right for you at the time. Your student loans will be a part of this decision.
One of the first things you must do when looking to buy a car is figure out how much car you can afford. This requires a close look at your finances. Sometimes you need a little reorganization to make them fit with your goals.
If you can pay cash, that’s great! The amount of cash you have is your budget. Don’t forget to account for dealer fees and extras.
If you need to finance your new vehicle, you’ll need to plan a little more.
Take a look at both your income and expenses to figure out what kind of car payment you can afford. Don’t forget to factor in car insurance, especially if you don’t have it now. It’s illegal to drive a car without insurance, so it’s essential to incorporate it into your budget. Estimate how much you will be spending on gas each month. Factor in maintenance, both routine and irregular. Account for all your expenses aside from the car, even the ones that seem trivial or vary from month to month. You want to ensure you can still afford those even after adding a car payment to your monthly budget.
Of course, your student loan payment would be on that list. Remember to include any potential increases in your student loan payment during the term of your car loan. For example, if you are on a graduated repayment plan in which your payment increases every two years, leave room in your budget for those increases.
From there you should be able to calculate what you can afford, which will help guide you in your pursuit for a car loan.
Shopping For A Car Loan
While this is not nearly as fun as shopping for the car, it’s necessary to get the best deal — one that cooperates with your student loans.
It’s a good idea to shop around for a car loan before approaching a dealership. You can often get a better deal from an outside lender than you’d get from the dealership. You can even use those deals as bargaining tools to get the dealership to try to beat it. Either way you go, you’ll be much better equipped if you shop around first.
Like getting a mortgage, getting approved for a car loan depends on your debt-to-income ratio (DTI) and credit score. Generally, lenders want to see a DTI of under 36% and an excellent credit score. But if you don’t fall under that umbrella, it may not be the end of your search.
Some lenders will work with higher DTIs and lower credit scores. That’s great for those with student loan debt, but it means they’ll likely end up with higher interest rates and longer loan terms. Similar to student loans, the higher the interest rate and the longer you make payments, the more you’ll pay over the life of the loan.
Let’s look at DTIs and credit scores in a little more detail.
Your debt-to-income ratio (DTI) shows how much of your income goes to paying off debt each month. If that number is too high, you might not be approved for a loan.
How do you know what your debt-to-income ratio is? This involves a little math, but it’s not that hard. Add up all your debt payments and divide that by your gross income. Don’t include expenses like utilities or food costs; just rent or mortgage and minimum payments on borrowed money like student loans and credit card purchases. Multiply your answer by 100 and you have your debt-to-income ratio.
Different lenders may have different thresholds for DTIs they are willing to work with. Expect to get the most approvals with a DTI under 36%. If yours is higher, it’s still possible to get a loan, but it’ll likely have a high interest rate and you’ll pay a lot more overall.
Troubleshooting Your DTI
If your DTI is too high, there are things you can do improve it. The two options are to lower your debt or increase your income.
Lowering your debt may be the easier option, but it can take time. The simplest way to do this is to pay down your current debt and not take on more. If you need some help coming up with a plan, there are two strategies that may get you in the right mindset.
Another option is to lower your current debt payments. For federal student loans, you have access to a host of repayment plans that may lower your payments. The most popular options are the income-driven repayment (IDR) plans.
A word of caution about those: Some car buyers have reported difficulty getting a loan because of student loans on IDR plans. They express frustration because lenders don’t always know how the programs work, especially when the buyer’s credit report shows multiple payment amounts. They tend to practice caution and use the higher amount, throwing your DTI off balance. However, some lenders are willing to work with buyers to learn how the programs work, increasing the chances of approval. Cast a wide net and on’t give up!
If you have private student loans, you can look into refinancing. It’ll restart your loan term, but you can choose terms that will lower your payments to allow you to get a car loan. However, this is a balancing act. We don’t suggest choosing the longest loan term just for the lowest payments — you’ll end up paying much more over the years. Instead, consider a payment low enough so your DTI qualifies you for a good auto loan. Remember, the shorter the term, the less you pay in interest.
The second thing lenders look at is your credit score. When you see deals for 0% APR or no down payment to get a car, only the highest credit scores are eligible for those deals. Additionally, the higher your credit score, the lower the interest rate you’re likely to get.
For that reason, you want your credit score to be as high as possible when you apply for a loan. Depending on your financial situation, your student loans can work for or against that goal. If you consistently make your payments, your credit score will be higher. If you are delinquent or default on any loans, your credit score will suffer. Plus, it takes seven years for those bad marks to be removed from your credit report, so maintaining good payment habits is essential.
If you find yourself falling a bit short financially, it’s a good idea to take a step back from your search and make a plan, assuming you have some time to do so. That could mean doing one of many things:
The Rest Of The Car Buying Process
When buying a car, part of the process is about finances and the other part is about the car search. That’s the fun part and should be enjoyed. However, if you want to shop smart — and we’re guessing you do since you’re here — there are some things you can do that will make your dealership experience easier:
In the end, your best chance to buy a car when you have student loans is to be smart. Plan your finances and make changes if you have to. Come to the conversation informed and ready so you know if the lender or dealer is not giving you the best deal.
At the same time, know your true budget so you’re not driving off with a loan you can’t really afford.
Have you ever bought a car with student loan debt? Would you consider ever consider it? Why or why not?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.