So you have decided you want to refinance our car loan. Luckily, with Pacecar it can be easy to find a lender to work with. But what things determine your approval and the offers you will receive? Here are four important factors:
1. Paying your current auto loan on time.
This one deserves emphasis, even if it seems obvious. According to Experian, just one 30-day late payment will affect your Vantage and FICO credit scores. Further, while auto refinance lenders will look at all your accounts’ payment histories, they will examine how you have paid your prior auto loans especially closely. And trust us, they’ll be looking, regardless of how external events (including pandemics and unemployment trends) affect your budget.
NPR recently reported that government protection programs provide no guarantees that your credit won’t be harmed once the nation recovers and forbearance-delayed payments become due again. Avoid falling in to the trap of trading short-term gain for the long-term gain that will come later.
Late or missed payments on any loan, credit card or other account show up on your credit bureau, and can negatively affect your credit risk profile. So, to be clear, avoid late payments as much as possible!
2. The depreciation of your car.
Almost every car’s value declines over time. In fact, newer cars (those in their first year of use) depreciate faster than pre-owned units. That’s right: a car’s value declines more in its first year of existence than it does in any other year of its life.
This affects your ability to refinance because it means your Loan-to-Value (LTV) ratio, which has a big impact on a lender’s willingness to offer you a refinance loan, could actually increase in your first year of ownership of a new car. Generally the higher your LTV the harder or more expensive it will be to refinance your loan, so lower LTV ratios are better.
Let’s look at an example. Say you agree with your seller on a $30,000 price for a new car, and you purchase $1,000 worth of warranty and GAP products and you are able to put $3,000 as a down-payment. At a 7.5% tax rate, you’re financing $30,325 for the purchase. This means your beginning LTV is (30,325 ÷ 30,000) 101%. Not a bad LTV to start, but watch what happens next.
According to Carfax, most vehicles depreciate (fall in value) by 20% during their first year, and 10% per year for the next 4 years. In our example, this would mean that the vehicle purchased new for $30,000 would be worth $24,000 by the end of the 12th month. Assuming a 10% APR, the remaining balance on the original $30,250 loan would be $25,404 after 12 payments. This means the LTV after one year will have climbed to 108%!
Not to worry – this elevated LTV is temporary. The good news is that depreciation, according to Carfax, is less severe in years 2 through 5 (about 10% annually). So by the end of year two, our principal balance will have declined to $19,968 while the vehicle will have depreciated to $21,600, for an LTV of 95%. A sub-100% LTV will be viewed as a reasonable risk by most lenders.
This example illustrates two things: First, it may actually be harder to refinance your car loan 12 months in to your ownership of a new car. And second, your ability to refinance will only improve during the second, third, and fourth years of a car’s life.
3. Your other pieces of debt, and how you pay them.
While it is true that lenders look especially closely at prior auto loan payments when assessing a borrower’s credit risk (see #1), they examine how you pay the rest of your bills as well. On-time mortgage payments over a long time indicate financial stability, while just a few delinquencies can raise a lender’s concerns.
Additionally, the number of and size of your other debt affects how risky or safe you appear to a refinance lender. High levels of revolving debt are a red flag, so avoid an excessive number of credit cards (generally more than 2 or 3) with unpaid balances.
You should also avoid too much automotive debt. Specifically, more than one car loan per adult driver in your household will cause you to present riskier profile to lenders.
4. Mileage and Maintenance
This one is pretty simple. If you maintain your car according to its recommended schedule and drive an average amount of miles per year (around 12,000) you are helping your chances of saving big with a refinance. So don’t neglect your oil changes and other scheduled maintenance, and try to avoid driving much more than 12,000 miles or more annually, and you’ll improve your odds for a money-saving auto loan refinance.
By Casey Harmon
Casey Harmon is the Co-Founder and CEO of Pacecar Inc. Before founding Pacecar, Casey held various executive positions at Westlake Financial and Toyota Financial Services. He has an MBA from UCLA Anderson and a BA from Stanford. Casey believes all American car drivers should have access to the best loan terms available. Casey lives in the Los Angeles area with his wife and two children.