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New year, new you… new auto loan?
The turning of the calendar is always a great time to revisit and set new financial goals. Considering the uncertainty and instability of last year, 2021 is the ideal time to prioritize your personal finances.
How? By setting a New Year’s financial resolution.
And there are plenty of options. You could focus on managing your lifestyle expenses by budgeting. Or you could open a new bank account and establish an emergency fund (if there was ever a year to have one, it was 2020). And, if you have an eye on the future, you can allocate more funds to your IRA or investment portfolio.
But your path to accomplishing your financial goals in 2021 could be your car — specifically, your car loan.
Let’s walk through why your financial New Year’s resolution should be refinancing your auto loan — and five reasons why it may not be the right time for you.
If you’re not happy with your current auto loan, there are several reasons to consider refinancing and getting a new, better car loan.
If there’s a silver lining to a recession — and, we know, it’s hard to find one — it’s that interest rates are still low. While that’s bad news for savings accounts, it’s helpful for current and prospective borrowers, who can use refinance loans to reduce their monthly payments and overall loan interest.
By how much? The RateGenius State of Auto Refinance: 2021 Report found that most borrowers saved over $900 per year, on average, after refinancing in 2020. That keeps more money in your pocket during a financially unpredictable time.
The RateGenius State of Auto Refinance: 2021 Report found that most borrowers saved over $900 per year, on average, after refinancing in 2020.
Sometimes car buyers have to take out subprime loans with less favorable terms. If you had a bad credit score or limited credit history when you took out your current loan, that could be the case.
Let’s say you implemented a financial New Year’s resolution in 2020, achieved financial success, and improved your creditworthiness. For example, if you started a side gig, received a promotion, or got a new job that pays more (congratulations, by the way), you may be eligible for better terms and a lower monthly payment.
Or maybe you cut back on your spending and saved more each month, paying down debt in the process. In either case, these efforts would likely increase your credit score and lower your debt-to-income ratio (DTI), making you a more attractive borrower. In turn, you could be in the market for a refinance loan with better terms.
Unsure if your credit improved? Getting a free credit report is easy. You can also sign up for credit-improving services like Experian’s Boost where you can bump your score instantly.
Less money coming out of your pocket is always a good thing. What’s even more prudent? Applying the savings from your reduced monthly payment to your other forms of debt, such as credit card debt, student loans, and mortgages. According to a RateGenius customer survey, 24% of borrowers refinance their auto loans in order to pay off credit card debt.
That can be reason enough to replace an expensive auto loan. However, if you then applied those savings to other forms of debt, you could reduce your total debt.
That’s like packing two financial New Year’s resolutions into one.
If you’re dissatisfied with your lender, 2021 could be the year to find a financial institution that meets your needs and preferences. And that doesn’t necessarily imply that you had a harsh dispute with your lender in 2020.
They could be doing a serviceable job, but if you prefer a lender with a more user-friendly website and lending platform, there could be a better option out there. Or, if you’d prefer to bank with an institution that can provide a wider range of services, you may want to explore larger banks or try one of your local credit unions.
Applying for a loan with someone else can make it easier to get approved. On top of that, it can help you get better terms and a lower interest rate than if you applied by yourself.
Better terms. Lower monthly payment. Everybody wins. Right?
Not necessarily. This symbiotic situation can reverse course if you and your co-signer or co-borrower are separated for whatever reason. If you found yourself in this unfortunate situation, you’re not stuck. You have options.
You also don’t need a breakup to justify removing someone from a loan. Maybe it’s your first car and your parents co-signed the loan to help you out. If your financial profile has improved since then and you want to be financially independent, you might be able to qualify by yourself.
While there are plenty of solid reasons to refinance your auto loan, that doesn’t mean it’s always a good idea. Here are five reasons why it might not be a good time to refinance.
A good credit score alone doesn’t make you eligible for a car refinance loan. Your vehicle factors into the equation too. For instance, many lenders may require that your car should be less than 12 years old and have less than 125,000 miles. Otherwise, it might not qualify.
It’s no secret: Lenders look at your credit score to assess your riskiness as a borrower. If you have a strong credit score, that demonstrates your reliability as a borrower. If you have bad credit, issuers may hesitate to give you a loan.
While it’s far from the only factor that lenders consider, your credit score and credit history will impact your ability to refinance your existing loan. Unfortunately, there isn’t a universal score to strive for that will guarantee approval.
Again, if you have a lower credit score, you’re not out of luck. But you might want to work on improving your credit score first before applying.
2020 was a tough year for a lot of reasons. One of which was the mass waves of layoffs. If your income took a hit as a result of the pandemic (or for whatever reason), you might not be in the best position to qualify for a refinance loan.
Beyond needing to see proof of a stable income and employment status, lenders generally require a DTI of 50% for refinance loans.
Your DTI compares your total monthly income to your total monthly debt payments. From an income standpoint, this includes salaried income or hourly wages, investment income, alimony, etc. From a debt perspective, your DTI considers all of your debt payments — not just your auto loan payment. Your student loans, mortgage/rent payments, minimum credit card payments, etc.
If more than 50% of your income is obligated to your debt payments or you recently lost your job, it’s unlikely that you’ll be approved for a refinance loan.
If your loan’s balance is higher than the value of your car, you’re upside down on your car loan. What does that really mean though? From a lender’s perspective, the investment would be risky if the underlying asset (i.e. your car) can’t be resold to pay off the full amount of the loan.
But before you panic, you can be upside-down on your loan and still qualify for a refinance. You just can’t be too upside-down. In other words, your loan-to-value ratio (LTV) can’t be too high. This metric compares your loan balance to the value of your vehicle. For instance, an upside-down loan has an LTV of greater than 100%.
According to RateGenius data collected from 2015 to 2019, 90% of approved applicants had an LTV of 123% or lower.
It’s possible to qualify with an even higher LTV, but it will depend on the lender.
If you had to settle for a subprime loan when you first purchased your car, you might have less than ideal terms — such as a prepayment penalty. In essence, you incur a prepayment penalty if you pay off your loan balance before it’s due.
This fee can offset the would-be savings of a refinance loan, so you’ll have to compare your interest savings to your penalty amount to see if it’s worth it.
Last year was tough, so it’d be good to start 2021 on the right foot from a personal finance and money management standpoint.
If you choose to prioritize saving, exploring auto refinance loans could be a fruitful endeavor. An additional $900 of savings per year can do a lot to improve your financial situation, whether you choose to max out your retirement savings or pay for advisory services.
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