If you’re buried in student loan debt and you’re considering buying a car, you may not know where to begin. The following information is everything you need to know if you’re buying a car with student loan debt.
How Much Can You Afford to Spend on a Car?
Do You Have Savings?
You’ll need to take a look at your savings and decide how much of that you’re willing and able to put toward a new car. If you have enough saved up to pay for a new car in cash, that’s great!
Paying in cash is always preferable to financing a new car purchase, as long as you have enough to buy something that’s going to last you a while and meet your needs.
If You Don’t Have Savings, Make a Budget First
If you don’t have enough saved up to purchase your new car, you still have the option to finance with an auto loan. Create a basic but thorough budget, showing how much you earn each month and how much you spend. Whatever you have left over is the amount available to go towards car payments if you take out an auto loan.
Generally Accepted Auto Loan Payment Ratio
Generally, if you need an auto loan, you should not exceed 20% of your take-home pay as your monthly payment. Play it safe and try to stay closer to 10-15% if possible.
Choosing the Best Auto Loan
Choosing the right lender and loan can be complicated, even when you’re in perfect health financially. When you’re buying a car with student loan debt, it’s even more difficult.
Here are a few tips to make sure you get the best deal when you’re looking at auto loans:
Look at the total
It may be tempting to look only at the monthly payment you’ll be making on an auto loan. But when you’re shopping loans, look at the total cost over the full term (price of the car plus interest). Lenders will often suggest enticingly low monthly payments on vehicles that are well out of your price range.
Know your lender
Another important step is researching your lender as well as you can before you sign anything. If you find out a lender is known for offering subprime loans or for pushing extended terms, and that’s not what you want, you may want to shop elsewhere.
Separate the car from the lender
Remember that you’re shopping for two different things: a car and a loan. Before you start shopping for a car, decide how much you want to put down and how much you need to borrow, based on your budget. Then, begin applying with credit unions, banks, reputable online lenders, and your auto insurance company.
Take two weeks to apply
Every time you apply for a loan, your credit score takes a hit. If you apply for 10 loans over the course of a year, you’ll get 10 separate hits on your credit score, which can bring your score down noticeably, making it more difficult to qualify for good loan terms. If you apply for every one of your auto loans over the span of two weeks, however, they will only count as one loan inquiry.
Research and compare
When you’re comparing auto loans, focus on the APR. A lower APR can result in thousands of dollars saved over the course of several years. Also look at the loan term. A shorter term will result in higher monthly payments but less interest paid overall. A longer term will result in lower monthly payments but more interest paid overall.
After shopping loans, getting preapproval can give you the peace of mind that you qualify for a loan with decent terms. To gain pre-approval, you’ll need to have an estimated cost of the vehicle, plus taxes and fees, minus the down payment you plan to pay.
Don’t sign anything until you’ve read all of the fine print. Things you may want to avoid in a loan include prepayment penalties (fees if you want to pay off your loan before the end of the term), mandatory binding arbitration (preventing you from taking your lender to court), and variable interest rates (your lender can change the interest rate). If there’s anything in the loan documents you don’t understand, ask for clarification.
When you’re shopping for an auto loan, the best thing you can do is take your time. While this isn’t always an option, if you’re able to take time to shop different lenders and do your research, it can end up saving you a lot of time and money. This is especially important when you’re already burdened with student debt, and you don’t want to risk damaging your DTI, credit, or overall financial health further by taking on a loan you can’t afford.
Buying a Car in College
If you’re still in college, the decision to purchase a car can be even more complex. Your finances likely aren’t in the best shape, and you may not have a reliable source of income outside of your financial aid. If you’re in college, and you’re considering buying a car, there are several important things to consider.
Can You Use Your Student Loans to Buy a Car?
While student loans are meant to be put towards school expenses, you can use your student loans for living expenses.
If you receive federal financial student aid, you must agree to use your loans strictly for educational purposes, which means you cannot take out a federal student loan for the sole purpose of buying a vehicle.
However, if you’re like many college students and you’re without reliable income aside from your student loans, you may not have an alternative method of paying for a car. If a car is a necessity caused directly by your enrollment in college, and you don’t have enough cash saved up, a portion of your student loans can go towards your monthly auto payments. You still need to go through the process of applying for a separate auto loan. Then, your monthly payment may be considered a school-related living expense.
What you should never do is take a lump sum portion out of your student loan to pay for your vehicle in cash. Additionally, unless it’s absolutely necessary in your case, it’s never a good idea to turn to student loans to fund a purchase like a car.
If you’re in a crunch for transportation and your primary source of support is student loans, it may be a better idea to look into leasing a car: monthly payments on an auto lease are often significantly lower than auto loan payments, and you won’t be taking on new debt.
Can I Get a Car Loan As a College Student?
As a student, your options for financing a car are likely more limited, but you can still get a car loan as a college student. However, if you have very limited income and you don’t have good credit (or any credit at all), banks and credit unions may be reluctant to work with you.
Many lenders offer special loans for students but be wary of these loans: They often have far worse terms than regular auto loans. To make up for the perceived risk they’re taking by lending to students, lenders typically raise the interest on student auto loans significantly.
These loans are known as subprime loans and can carry APRs (annual percentage rates) up to 29.99%. For comparison, a borrower with good credit can get an APR of 5.29%–a difference that can add up to thousands of dollars over the course of a loan term.
While this sometimes may be your best or only if you’re in need of a car, there are several alternatives for students who are considering an auto loan:
- Conventional loans
Rather than choosing a student-oriented auto loan, you may be able to qualify for a standard auto loan. This is, however, only if you have established credit, proof of income, and a decent DTI.
You may be able to qualify for better loan terms with a co-signer. This would be a relative (usually a parent) with proof of income and a good credit score. Your co-signer agrees to take on responsibility for repaying the loan if you fail to do so.
If you choose this option, make sure you and your co-signer come to an agreement that you are the one responsible for monthly payments, and decide what you’ll do if you become unable to pay.
Do I Need a Car in College?
If you’re still in college, you may be able to avoid the hefty financial burden of buying a car. Whether or not you need a car depends on a variety of factors:
- How far do you live from campus?
- Do you work off-campus?
- How large is campus?
In addition to auto loan payments or the cash you’ll need to pay up front, make sure you consider additional costs like parking and gas.
If biking to and from campus or carpooling is a possibility, you may be able to forgo the stressful and costly purchase of a car.
Tips on Saving for a Car in College
If there’s no rush to buy a car, your best bet is to save up your money as long as you can and pay for a car in cash. If you do plan on taking out an auto loan, it’s also a good idea to save for a while so that you can put down a significant amount, thus lowering your monthly payments and/or term.
Saving money when you’re in college can be rough, but there are some things you can do to put money in your piggy bank:
- Cook more and eat out less (and use your meal plan if you have it).
- Always check for discounts, especially for purchases like laptops and software.
- Avoid paying full price for textbooks.
- Choose housing you can easily afford.
- Use campus amenities.
- Ask your local bank or credit union about special accounts for students.
- Skip Starbucks and invest in a coffee-pot.
- Use Wi-Fi instead of data.
- Search top jobs for college students that you can do in your spare time.
How Do Student Loans Affect Getting a Car Loan?
Student loan debt can affect your decision to buy a car and your ability to get a car loan in a few different ways:
Debt-to-income (DTI) ratio
Student loan debt, like any other type of debt, affects your debt-to-income ratio, which impacts your loan eligibility.
Student loans can impact your credit score positively or negatively, depending on how well you keep up with your payments.
Depending on how significant your monthly student loan payment is, a monthly auto loan payment may be outside of your budget. Student loan payments can also take a toll on your ability to save for a down payment or to buy a car with cash.
Student Loans and Debt-to-Income Ratio (DTI)
Your debt-to-income ratio (DTI) is the calculation of how much you pay in debt expenses per month compared to your monthly income. It shows potential lenders how much of your income goes toward paying off your debt each month, which allows them to decide whether they think you’re capable of taking on a new monthly expense.
If your DTI is too high (you pay too much in monthly debt expenses compared to your monthly income), you may not be able to get approved for an auto loan.
How Do Student Loans Count Against Your DTI Ratio?
Student loans get calculated into your DTI just like any other debt payment. Rather than considering how much you owe on your student loans in total, lenders who calculate your DTI look at how much of your income goes towards paying off that debt every month.
Each lender has their own threshold when it comes to DTI, but you can calculate your DTI to get a sense of whether or not you might be approved by most lenders. If your DTI is under 36%, you have a good chance of getting a loan.
Calculate Your Debt-to-Income Ratio
To find your DTI, add up all of your monthly debt expenses and divide that number by your monthly income. Then multiply that figure by 100. That is your DTI.
Don’t subtract expenses like food and utilities from your income—lenders look at your gross income, which is income before expenses.
Debt expenses to figure into your calculation include:
- Mortgage payments
- Existing car payments
- Credit card payments
- Student loan payments
- Any other installment payments
DTI Calculation Example
Annie makes $3,000 per month at her job.
She adds up her monthly minimum payments for student loans, credit cards, and other debts, and gets $1,000.
To find her DTI, Annie would perform the following calculation:
Monthly debt payments ÷ Monthly gross income = Y | Y x 100 = Debt-to-income ratio
$1,000 ÷ $3,000 = 0.33 | 0.33 x 100 = 33
How to Improve Your DTI When You Have Student Loans
If you calculate your DTI ratio and it’s over 36%, don’t give up hope of buying a car with student loan debt. If you have time to work on your finances before buying a car, there are ways you can work toward improving your DTI.
Even if you decide against buying a car with student loan debt, improving your DTI is a good idea so that you’re in good standing for future purchases. You can recalculate your DTI each month, using the above formula, to see how much improvement you’re making.
Increase Your Income
It might be easier said than done, but the first way to improve your DTI is increasing your monthly income. If you already know you’re in line for a promotion at work, or you’re due for a raise, your DTI will improve all on its own. If not, you might consider other ways of raising your income, or consider waiting until your income is higher to buy a car.
Lower Your Debt Expenses
While still difficult, lowering your debt expenses may be the easier option when it comes to improving your debt-to-income ratio. Your total debt isn’t what’s calculated here, so your goal is to minimize your monthly payments. If you’re buying a car with student loan debt, this can be a good first step.
If your student loans are federal, you may be eligible to enroll in an income-driven repayment plan (IDR). Be cautious if you choose this option, however, as some auto lenders don’t understand how IDR works and may miscalculate your DTI.
If you already have an IDR plan, or you think this may be the best option for you, make sure you find an auto loan provider who understands IDR plans or is willing to learn.
Student Loan Refinancing
Another option you have if you want to minimize your monthly student loan payments in order to improve your DTI is refinancing your student loans. Refinancing your student loans can help you when you’re buying a car with student loan debt in two ways:
- Refinancing can lower your monthly student loan payment, which will result in a lower DTI.
- Refinancing can allow you to put more money towards saving for a car, if you’re planning to pay in cash or put down a larger down payment.
Learn more about student loan refinancing and consolidation.
Student Loans and Your Credit Score
Another thing lenders look at when you apply for an auto loan is your credit score. Keep in mind that when you see promotions like “0% APR” or “No Down Payment,” those only apply to applicants with high credit scores.
Applicants with fair or poor credit will qualify for less-favorable loan terms or may not qualify for a loan at all. As a rule, the lower your credit score, the more interest you’ll have to pay on any loan. If you aren’t sure what is considered a good credit score, this guide is for you.
Do Student Loans Impact Your Credit Score?
Carrying any type of debt always affects your credit, but not always negatively. Depending on whether you make your payments on time or not, your student loans can work towards improving your credit score, or they can quickly bring your credit score down.
How to Improve Your Credit Score with Student Loans
Improving your credit score when you have student loans is fairly simple. There are even ways to improve your credit score in 30 days.
Pay On Time Every Time
If you want your student loans to help your credit score (and not hurt it) you have to make your payments on time, every time. Even a single missed payment can negatively impact your credit. Enrolling in auto-pay is one of the best ways you can ensure your payments are made every month like clockwork.
Pay a Little Extra
Another way you can improve your credit score when you have student loans is by paying more than you owe each month, or whenever you have extra cash available. This also applies to credit card debt and other installment debts. Try to pay off your student loans early if possible.
Check Your Credit
It’s important to check your credit score regularly if you’re trying to improve it and to make sure there are no negative marks. If you see something incorrect in your account, make sure to file a report with one of the three bureaus right away. If you see that you have any debts in collection, make those a priority to get paid off as soon as possible.
Avoid Taking on More Debt
While you’re planning and saving to buy a car, it’s important to avoid taking on new debt. You may consider charging less to your credit card and not applying for any additional loans for the time being.
Timing is Everything When Buying a Car
Buying a car, even when you don’t have student loan debt, can be one of the most difficult purchases you’ll ever make. The most important thing to keep in mind when you’re considering buying a car with student loan debt is that right now may not be the best time to buy. Large purchases take time to do right. Especially when you have a large amount of student debt or you’re still in college, taking the time to budget and plan is essential to successfully buying a car.